The Language Of Hard Times | February 2, 2009 Issue - Vol. 87 Issue 5 | Chemical & Engineering News
Volume 87 Issue 5 | p. 22 | Insights
Issue Date: February 2, 2009

The Language Of Hard Times

No matter how chemical companies say it, it's all about the Benjamins
Department: Business
Credit: iStock
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Credit: iStock

THIRTEEN MONTHS into the recession, U.S. chemical executives can be divided into two groups: those still emphasizing the positive and those talking openly about the tough decisions they face.

Whether the public statements are sunny or grim, they all contain phrases that are peculiar to a downturn. Gone is the talk of growth, innovation, and entering new markets. Now, executives say they are "focusing on cash flow" or "concentrating on core businesses." Although the messages are sent with investors in mind, company employees should understand how these signals affect them.

On Jan. 16, Lubrizol sounded upbeat even as it lowered its 2008 earnings estimates. "Our balance sheet is strong; we are taking the necessary steps to meet the challenges of 2009," said James L. Hambrick, the firm's chief executive officer. Lubrizol explained that it will cut costs by $40 million to $50 million this year. So far, the plans do not include layoffs.

PolyOne, in contrast, announced a second round of layoffs on Jan. 15. To save money, the company is "eliminating approximately 370 jobs worldwide, implementing reduced work schedules for another 100 to 300 employees, closing its Niagara, Ontario, facility, and idling certain other capacity."

Many chemical companies are in a position somewhere between these two extremes. On Dec. 19, for example, Albemarle said it "aims to achieve $40 million in annualized cost savings next year by accelerating cost-reduction programs and resizing its business footprint. The company is keenly focused on maximizing cash flow through working capital reductions and prudent capital spending."

THE CAREFUL wording of Albemarle's statement says a great deal about how the company plans to steer through the crisis. The business lingo signals a change in management priority toward spending cuts and other moves that preserve cash.

The long recession has revived the cliché that "cash is king." A company's cash flow comes from its day-to-day operations. It's money that flows in from customer payments and returns on investments minus expenditures for inventory, labor, and interest. Positive cash flow is like a spring-fed fountain, supplying cash for business investments, dividends, and debt payments.

Cash and cash flow should not be confused with similar-seeming terms such as revenue, income, earnings, or profits. Only when a company shows positive cash flow can it generate more cash than it spends and continue to operate successfully.

To create positive cash flow, companies start with a bucket of money called working capital. Working capital cycles throughout an organization as blood circulates in an organism. With working capital a company can purchase supplies and extend credit to customers. Without this "liquidity," a company would need to collect payment before it begins manufacturing its product, which is a tough way to do business.

Gone is the talk of growth, innovation, and entering new markets.

To fund working capital, companies use existing cash reserves, cash received from customers, credit from suppliers, new equity or loans from shareholders, short-term bank loans, or long-term debt.

Today's liquidity crisis reflects the common practice of funding working capital with borrowed money. That was fine when credit was plentiful and interest rates were low, but now companies need to generate more of their own cash to fund operations and pay back debt built up in previous growth phases.

Firms like Albemarle hope to free up cash that is tied up in working capital as inventory and IOUs from slow-paying customers. By reducing inventory and pressuring customers to pay quickly, firms can increase cash flow.

Other companies find they need to do more than squeeze working capital. Executives at these firms have seen demand for their products fall off a cliff, and they can't count on outside financing, current profits, or stock offerings to fund operations.

Such firms face the danger of burying all their cash in an ever-growing pile of unsold inventory. They must quickly "restructure," "resize," or "reorganize." Basically, they must shrink to exist in a world of smaller demand.

These are the hard decisions that business strategy consultant Ram Charan writes about in his new book, "Leadership in the Era of Economic Uncertainty." He describes how DuPont, with CEO Charles O. Holliday Jr. at the helm, invoked its "corporate crisis plan" last fall to respond to the economic downturn. Within weeks of the first hints of decreasing demand, each DuPont employee was asked to identify three things he or she could do immediately to help conserve cash and reduce costs.

To reduce their business footprint, executives typically cut salaries and expenses for sales, marketing, and administration. They sell businesses that do not generate cash—or generate it slowly—and lay off workers and contractors. Or they sell long-term assets like land or equipment. Then they redirect resources to their "core business," the one that brings in the most secure cash flow.

In better times, having a large amount of cash sitting around was considered tacky. Shareholders expected to see cash paid out as dividends, or reinvested in the business. Now, instead of reinvesting, companies are cutting back on capital spending, the investments in long-term assets that generate future cash flow.

Making efficient use of working capital is a good business practice. But decisions that result in layoffs and delayed investments actually contribute to the crisis. Companies that do not invest in their future risk seeing their stock prices continue to wither. And when they lay off workers, they add to unemployment, killing demand for the products they are trying to sell.

 

Views expressed on this page are those of the author and not necessarily those of ACS.

 
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