Spare yourself from a capital crisis; mismanagement can occur in the blink of an eye when business circumstances change. There can be no quarreling with the overarching principle: managing working capital is vital.

AuthorPate, Carter
PositionCorporate Restructuring - Column

MOST FAILING COMPANIES are about to run out of the indispensable fuel of a going business -- working capital. But such a crisis is nearly always a result, not a cause, of a long series of previous follies, typically stemming from a faulty business model.

Even a good business model isn't insulated from unexpected changes: A competitor suddenly emerges with a better, cheaper, faster solution; new laws or regulations shrink the market for your product; consumer tastes swerve in another direction; or the economy plunges. As a result, huge amounts of inventory back up in the warehouse, tying up equally large amounts of working capital. But this didn't originate as a working-capital problem. The real issue is that customers aren't buying the product in the quantities or at a price that could make the company viable.

Most of the working-capital crises we see can be compared to the final stages of a fatal disease. While respiratory failure may be the technical cause of the patient's death, the cancer that caused it has been doing its lethal work for months or years.

One common manifestation of a working-capital crunch is when a company decides to buy rather than lease brick-and-mortar assets, then sinks considerable capital into a new state-of-the-art distribution center. With most of its money tied up in the new building and equipment, the enterprise is hardpressed for cash to pay its current expenses and bills, let alone for funding ambitious programs to market its products. This organization has genuine cash flow problems. Fortunately, it can be salvaged. In this case, the business is sound and, except that it invested too much money in building and equipment, runs perfectly well. Hence, odds are it will emerge from its working-capital crisis as long as a suitable way for it to derive cash or liquid assets from the bricks and mortar is found.

The wisdom of regular checkups

A basic rule for all businesses, whether they are booming, busting, or recovering from a financial stroke, is that if you carefully follow the ebb and flow of your working capital, you are very likely to spot problems in time to prevent serious damage, if not avert them entirely. Managing working capital astutely is far more than bean counting; it can work as an early warning system informing you that profit margins aren't what they should be and need immediate attention.

If your organization's key working-capital ratios, such as current assets to current liabilities, fall...

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