10 Steps to Build a Liquidity Cushion

The Lessons of Bear Stearns Available Cash = Acquisition Opportunities

Bear Sterns insisted that it didn't actually have a liquidity crisis. It fell victim to rumors that it was in a cash crunch. March 10, 2008: In a press release, Bear Stearns denied market rumors regarding the firm's liquidity, stating there was "absolutely no truth" to them. President and CEO Alan Schwartz said: "Bear Stearns' balance sheet, liquidity and capital remain strong."     Some observers suggest that with a liquidity ratio of 171 percent, the bank should have been able to continue financing its operations for another 20 months. That ratio is a company's total dollar value of cash and marketable assets divided by its current liabilities -- in other words, the extent to which a company can quickly liquidate assets to cover short-term liabilities.      But investor panic caused a run on the company's prime brokerage unit, which left the financial giant without enough cash to continue operating.     Meanwhile, JP Morgan Chase & Co. had the liquidity to step in and acquire Bear Stearns at a distressed price. March 17, 2008: In announcing that it was acquiring Bear Stearns, JP Morgan stated that it was pleased to be obtaining "an attractive set of businesses."  Chairman and CEO Jamie Dimon said: "The transaction will provide good long-term value for JP Morgan Chase shareholders. This acquisition meets our key criteria: we are taking reasonable risk, we have built in an appropriate margin for error, it strengthens our business, and we have a clear ability to execute."     Bear Stearns' cash shortage prompted the Federal Reserve Bank to intervene and negotiate a $2-a-share bid by JP Morgan. But that astonishing low bid didn't sit well with shareholders, so Morgan increased its bid to $10 a share, valuing Bear Stearns at about $2.4 billion.     How did JP Morgan, with assistance from the Fed, have the liquidity to take quick advantage of its rival's problems? Analysts say Morgan proactively built liquidity in the early stages of the credit market crisis. Moreover, the company has remained disciplined in reducing holdings and suspending equity repurchases.

When it comes to liquidity, planning ahead is critical. Liquidity is often there when you don't need it and evaporates when you do.

1. Take time to ascertain your company's position. The key is knowing that your business can generate enough cash from its operations and liquid assets to provide fuel for survival and growth. A profitable company with significant value is of little use if it has no cash to pay creditors. 

Consult with your accountants about your company's liquidity or working capital ratio, which is examined by creditors.

If your company has too much cash tied up in assets, it may be hurting from unnecessary interest payments, bad debts from receivables or excess inventory.

Consider securing an emergency line of credit so that you can avoid paying high interest rates, from sources such as credit cards, when you need cash in a hurry.

2. Get payment, retainers or deposits from customers the moment sales are made.

3. Perform credit checks on new customers, particularly if they place significant orders.

4. Monitor accounts receivables to ensure that your company is collecting promptly. Cash is your company's lifeline. If receivables are high, they can drain cash and lead to failure.

5. If possible, negotiate longer payment terms with vendors, in order to hold onto cash for a longer period of time.

6. Sweep excess cash balances into an interest-bearing account when the funds aren't being used and sweep them back to your operating account when your company needs the money. 

7. Review overhead costs, which directly affect your business's profitability and look for opportunities to decrease them. Overhead expenses include rent, advertising, office supplies, as well as insurance, auto and truck expenses. Also eliminate unnecessary utility costs. 

8. Dump unproductive assets that your business is storing and not using. Generally, the only reason to spend money on such fixed assets as buildings, equipment and vehicles is to generate revenue.

9. Monitor the money that's being taken out of the business for items such as sports tickets, costly last-minute airline tickets, unauthorized overtime, expensive conventions, etc. Examine the cost and use of business vehicles by employees. Non-essential and non-business expenditures unnecessarily drain cash from your organization.

10. Review the profitability of your products and services. Determine where your company can increase prices to boost profits. Consider eliminating unprofitable products and services.

• Customer buying habits change.
• Sales turn flat or even decline by 20 or 30 percent.
• Your company faces 60 to 90 days without receiving payments from several large customers.
• Accounts receivable collections slow by five or 10 or 20 days.
• Lenders increase rates by one, two or three per cent or decrease your borrowing limits.
• Your largest customer fails.
• Existing creditors are unwilling to lend your business money or renew its credit. Keep in mind that the value and marketability of collateral, pledged to secure a loan, often dwindles during tough economic times.
• Competitors actively go after your accounts.