Managing Cash Flow - Beware the Economic Recovery
Monday, October 26, 2009
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An excellent recent article in the ACCA magazine examines an interesting phenomenon - more businesses collapse at the beginning of a recovery than during the depths of a recession. Its all to do with working capital…
Our good friend Hamish McRae is well quoted in the article, explaining how a switch in working capital as demand builds during an economic recovery can lead to good businesses going bust:
‘As demand declines, businesses contract, which reduces their need for working capital: they “live off themselves” as they get smaller. As demand starts to grow, businesses have to increase their production to meet it. Yet if they’ve spent their working capital just on keeping going through the downturn, they find it very hard to spool up when the recovery begins. This crunches their working capital.’
An economic recovery is associated with stockbuilding and capacity expansion - all potential sources of working capital and (therefore) cash flow problems.
Other factors come into play. A recovery typically comes with higher interest rates (bad news for businesses with high gearing). And well-established businesses that have survived the recession suddenly find themselves competing with many new start-up competitors that have been born in the downturn.
The article is well-worth downloading and giving to Year 13 students.
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