Trust Me: I'm Good For It

The recent financial troubles have taught me the importance of loans in the everyday running of business. The fact that loans are needed for large capital investments, like building a factory, is obvious. What is not obvious is that a majority of businesses seem to need loans on a constant basis for operating costs as well.

I had always assumed that a well managed business would keep reserves of cash handy to help smooth out the rough spots between the purchasing of inputs and the receiving of revenue. But apparently they don't. When the financial world was being brought to its needs, the business world seemed unable to turn their lights on at work. It seems finance has gone far beyond helping businesses acquire capital and upstart money. They are now as important to daily activities as management.

(1) I asked a business person sitting next to me on the plane why this was the case. He indicated he didn't know, but it certainly was. Virtually every business relies on frequent loans for day-to-day activities.

(2) One of my former graduate students now works at a bank. I shared these thoughts with him and he indicated he felt the same way before he worked at a bank. But he sees many businesses taking loan after loan for little things like buying inputs and paying employees. Loans, not cash reserves, are used for smoothing out revenues and expenses.

(3) I was greatly relieved to see an article from The Economist help clarify this issue. From All You Need is Cash in the 11/22/08 issue, they state...

SELDOM has corporate strategy been turned on its head so quickly. Barely a year ago, cash was a dangerous thing to accumulate: activist investors stalked companies, urging boards to return it to investors, to pay special dividends or to buy back shares. Ever since the 1980s the fashion had been to make companies as lean as possible, outsourcing all but your core competencies, expanding your just-in-time supplier system around the globe, loading up with debt to “leverage” your balance-sheet. Old-style defensive conglomerates, such as Arnold Weinstock’s General Electric Company, were dismantled. Companies that hoarded cash—even ones as good as Toyota and Microsoft—were viewed with suspicion.

No longer. For many big American companies, the day of reckoning came two months ago when the deepening financial crisis brought about the abrupt closure of the overnight commercial-paper market. This briefly sent even the most solid companies into a desperate scramble to find money to meet such basic obligations as paying their staff. Since then, the guiding principle for managers everywhere has been to gather up whatever cash they can find, and then do their damnedest to keep as much of it as possible for as long as possible.