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Brad Sparks
Brad Sparks
Corporate Survival in Today's Economy

One CFO outlines four distinct strategies.

March 16, 2009
by Brad Sparks

Put not your trust in money, but put your money in trust.
                                                  — Oliver Wendell Holmes, jurist

Over the past several years, accounting issues such as implementation of FAS 123R, introduction and monitoring of Sarbanes-Oxley procedures, stock-option dating and more have been at the forefront upon which every CFO must focus. But now, corporate survival issues now dominate the landscape. Although none of the accounting-related issues have disappeared, maintaining access to cash is critical to the survival of your business and much more difficult than it was in the recent past. Conditions warrant extreme caution and vigilance. With the turmoil experienced over the last months of 2008 which continues in the financial markets for 2009, CFO's need to be especially concerned about liquidity.

Lessons Learned

Over the years I picked up some valuable lessons from an experienced CFO who had learned "the hard way" during the '60s and '70s. In essence what he taught me was an early version of risk management when it came to managing cash.

I served on the treasury staff of a company in which he was CFP and where we were investing in overnight repurchase agreements (repos). Repos are a popular form of overnight borrowing. They are popular because they allow available funds to continually earn interest, even overnight. However, there are occasions of significant losses that occur due to fraud and lack of due diligence by investors. Does that sound familiar to anyone today?

Reader Note: Meet the author at AICPA's upcoming National CFO Conference in La Jolla, CA, May 14-15

That "wise" CFO made his staff walk him through the procedures underlying how all collateral securities including repos were handled just to ensure that they were kept absolutely safe. Could they be lost or stolen? Could they be switched? He was focused on making sure we had run all of the traps that could possibly be encountered in any situation. The training he gave us was the type that would allow his lieutenants to avoid investing in auction-rate securities, which so many CFOs later fell into. This CFO was very cautious; no careless errors affecting cash-flow were going to happen on his watch!

Today we would all be wise to do the same.

Why Firms Fail

One surprising feature of many failed firms is playing the yield curve, i.e., they finance long-term assets with short-term money. Normally, the financial markets experience an upward sloping yield curve in which the cost of borrowing funds requiring repayment over a short-time horizon is lower than those funds that will be repaid later. Interest rates on five-year notes almost always exceed those of one year. For the unwary, it seems smart to borrow at the low rates, invest in longer-term maturities or assets and pocket the spread between the two — particularly when we experience such a curve for years on end.

However, that behavior violates one of the most basic tenants which good financial management adheres to: matching maturities. The reason is simple: What happens if you can't rollover or repay the short-term debt? You are out of cash and must suffer the severe consequences of being in such a state, a precarious if not lethal situation, for any company.

Long-Term Cash-Flow Strategies

If the economic downturn we are currently experiencing lasts considerably longer than predicted by government officials, there is nothing to say that three and even five year notes are not short term, even if assets and securities financed by them are longer term in nature. Even normally safe short term commercial paper programs backed by bank-led revolving credit facilities convertible to term notes could fall into this matching maturities trap. And with the difficulties faced by the banking sector, those companies that have totally relied on their banks, rather than the financial markets, to insure their long term capitalization might find themselves in a serious liquidity situation should the financial markets stay depressed for an extended time.

Here's what you can do now, since the time to prepare the balance-sheet is in good credit markets, not bad:

  1. Good long-term cash-flow planning is mandatory. This planning should include — at a minimum — scenarios in which the short-term markets remain tight or even freeze up entirely and short-term debt cannot be refinanced. You also need to include scenarios in which the yield curve inverts and short-term debt is very expensive. CFOs cannot rule out a recurrence of the environment experienced during the late '70s when short-term interest rates reached levels over 20 percent per year. A large exposure to variable interest rates could be catastrophic;
  2. Match maturities with longer-term financial instruments should be undertaken. If available, the medium- and long-term debt markets should be tapped, along with equity sources and hedging techniques should be used to reduce interest rate risk;
  3. Pay attention to keeping the rating agencies informed about your organization. Without good information on your company, rating agencies may gravitate your firm towards a lower rating rather than a higher one and the difference could affect the availability of credit to your firm, especially in a tight credit market; and
  4. Spend whatever time is necessary to solidify and expand your banking relationships. Until the banking industry stabilizes, this exposure requires utmost attention.

All of these topics are extremely important and require attention from the financial staff.

Conclusion

To summarize, the emphasis for CFOs over the recent past has been on accounting issues, but now liquidity trumps all of the other issues. Managing cash-flow has always been important, but with tight financial markets, managing and ensuring its availability is essential for the survival of your organization.

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Bradley E. Sparks is CEO, president and director of Visualant, Incorporated, a Nevada corporation and a reporting company with the Securities and Exchange Commission. With over 30 years of high-tech and related industry experience, Sparks expertise ranges from guiding high-tech start up companies through IPO's to serving in senior financial positions for major public companies. Sparks was formerly CFO of WatchGuard Technologies, Inc. He also served as CFO for several telecommunications and high-tech companies, including Omnipoint Corp., Digex, Inc., eSpire Communications, and WAM!NET. He serves on the Listings Qualifications Review Panel of NASDAQ where he previously chaired the Issuers Affairs Committee.