Why are so many small businesses going bankrupt due to the coronavirus?
The obvious answer is that when customers disappear, the business has no income. However, that’s a superficial answer at best. It’s true, but it’s not a sufficient explanation.
The deeper explanation is that these companies retained too little cash to survive a downturn. Business interruptions happen, be they earthquakes, wars, epidemics or depressions. They’ve happened before, and they will happen again.
Pundits have predicted that technology would make business cycles obsolete.(1) Thus far, as we all should well know, that hasn’t happened. The concept is much like the paperless office. Maybe someday . . . .
However, business schools and books have taught that managers should use leverage (debt) to maximize profits. Cash-on-hand was something to be avoided lest a company buy you out and use your own cash to pay for all or part of the purchase. In theory, that actually has happened, but one has to be a relatively idiotic business owner to let it.
The problem with no having cash-on-hand comes when a downturn occurs. In general, banks lend when you don’t need the money, and for a small firm, even then will ask for your home as collateral for the loan. In a downturn, everyone needs money and your erstwhile friend at the bank makes himself very scarce.
The US government has stepped into the fray by making loans available to business. However, there are two problems with that program:
- The loans have to be repaid, unless then are absolved or “forgiven”.
- If loans are forgiven, they become taxable income to the business, and that can become a huge tax liability for a struggling company. Brilliant.
The commonplace about starting a company is that you need about six months of living expenses in the bank to make a go of it. These days, that’s probably not enough. However, once a business is a going concern, it needs the same cushion or more. Some companies thought they could create a cushion by buying business interruption insurance, but as the multitude of court cases are showing, that insurance isn’t a timely or sure guarantee of anything. The insurance company will claim that anything it cannot anticipate isn’t covered, and by the time the lawyers are done, there may be even less money to keep the business in business. No, a cash cushion is essential.(2) Further, the cushion has to be sufficient to protect both the company and essential employees.
That may be a fundamental less of Covid-19 for business managers. Live on the edge and die on the edge. Cash is still king, and you need to manage to keep a sufficient supply on hand.