It Is Easier To Fall Into Bankruptcy In A Recession

It seems pointless to spend a lot of time proving that companies are more likely to go bankrupt during a recession. Margins are hurt by bad sales. Firms cannot easily get access to capital to tide them over.

Hackett Group has come up with figures that demonstrate that it is harder to forecast cash needs when the economy is bad. Uncertainty about sales makes it difficult for managements to determine what they will have in their bank accounts.

According to Reuters, the Hackett Group chief research officer says “once you run out of cash you’re going to hit the bankruptcy cycle.” Hackett has gone to a lot of trouble to prove what is intuitively true, something almost every school child knows.

The antidote to cash problems has always been the same. Companies cut costs faster than their sales drop. This is, of course, the primary cause of rising unemployment. Taking costs and personnel down to the bone can save a company from coming to a bad end. A recession may make the process more difficult. Cuts can destroy a firm’s ability to do business at some point.

The analysis only tells a little bit of the story. Managements make as many cash flow mistakes in a good economy as in a bad one. They often have a greater margin for error when a rising tide lifts all boats, but poor executive execution has no season. Operations like Sony (SNE) and Starbucks (SBUX) prove that. They are lucky enough to have balance sheets to protect them from their own stupidity.

Airlines are another case in point. The best airline management, even management with unusually good forecasting ability, cannot save a company from rising fuel costs and falling revenue. The ability to look ahead intelligently allows a well-run carrier to cut routes and people, but those actions can be overwhelmed by the cost of goods and a lack of passengers.

Forecasting cash flow in a recession may appear more difficult that it is when the economy is growing, but that is only true if a company’s executives are unwilling to see the wave that will swamp them and do nothing to get out of the way.

Douglas A. McIntyre