The Business Book

(Joyce) #1


Farmers buying livestock at market
must—like many business owners—
pay up front. Costs, such as feed and
storage, will mount before they see a
return on their investment.

See also: How fast to grow 44–45 ■ Investment and dividends 126–27 ■ Making money from money 128–29 ■ Leverage
and excess risk 150–51 ■ Maximize return on equity 155 ■ Balancing long- versus short-termism 190–91


company may rely on dipping into
an overdraft to make up for a cash
shortfall. But when times are tough,
a reliance on the bank may be too
risky. A business needs to manage
its finances well enough to avoid
periods of negative cash flow.

How good companies fail
Cash is a constant pressure for
every new business. Even if the
company keeps to its start-up
budget, it takes time for trading
to reach a high enough level to
generate positive cash flows. For
example, a sports’ equipment
store may take three years to
build up the regular clientele that
will enable it to start making
money. Until then, the business
faces negative cash flow. So it
is crucial for new businesses to
prioritize cash flow from the
beginning. This may mean
leasing equipment, or buying it
secondhand rather than new, and
choosing suppliers that provide
the same credit period as the store
gives to its customers, even if these
suppliers cost a little more. Cash-

flow problems can also cause well-
established companies to stumble
and even collapse. In 1998, South
Korea’s Daewoo Group encountered
growing problems because of
“increasing difficulties in arranging
working capital and investment
funds.” The group had been
aggressively expanding, and

admitted that its overall financial
stability had been seriously
undermined by a new reliance
on borrowings, but insisted that
it was a brief moment of crisis.
Despite being one of the largest
conglomerates in the world, the
group collapsed the following year
due to massive cash shortfalls. ■

Money scams

US investment advisor and
financier Bernard Madoff was
sentenced to 150 years in prison
in 2009 following a money
scam that is believed to have
led to about $18 billion of losses
to investors. Although hailed
as a distinguished and expert
financier, capable of generating
very high returns for investors,
Madoff was in fact responsible
for running a “Ponzi scheme,” in
which cash from new investors
is used to pay generous returns
to earlier investors. The delight

of these early customers led
them to recommend the scheme,
which then continued to pay
earlier investors with the cash
put into the company by
subsequent investors.
This type of financial pyramid
is able to stay afloat as long
as sufficient numbers of new
savers put cash into the scheme.
If the flow of funds dries up,
the scheme collapses. Madoff’s
scam collapsed due to a loss of
investor confidence following
the 2008 financial crisis.

A business receives a $24,000 order, and has to plough cash into
making the goods. By week six, $20,000 has been spent by the company;
the customer is invoiced, but is not required to pay until week 13. This
means the company faces serious negative cash flow for 12 to 13 weeks.











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