In this depressed market, cash truly is king

Oilweek — The real significance of “cash is king” is being played out in the boardrooms of companies across the spectrum of the energy sector.

Those companies that have relied on cash flow from operations and on revolving lines of credit to finance inventory and growth have lately found themselves on the wrong side of their bank covenants. Significant penalties, as well as interest rates increases, have become the norm.

If you are the chief executive officer, president, or chief financial officer of an organization that has recently renegotiated its financing terms with a traditional bank, you can’t help but feel that you’ve been taken advantage of. But the use of leverage is a decision that largely derives from corporate culture and leadership personality.

It’s a risk game that can pay off enormously, or bury the show—some firms, who have tried to ride out the storm of depressed commodity prices, particularly of gas, have either re-invented themselves, or no longer exist.

When times were good in the energy sector, people were spending like crazy, and they lost their discipline in managing cash. Now, we are seeing the opposite approach, even carried to extremes: there are leaders of large, successful organizations who have put a stop to all business lunches and any team-oriented celebrations, only to see their cultures negatively impacted. Companies need to maintain the same financial discipline during difficult times as they do when business is booming.

So Where Can You Access Capital?

The Canadian chartered banks emerged relatively unscathed from the credit crisis due to Canada’s conservative banking laws, which are enforced by the Office of the Superintendent of Financial Institutions (OSFI).

Despite this comparative financial health, some in the energy sector would argue that the banks behaved inappropriately in some instances (for example, refusing to renew operating lines or charging exorbitant renewal fees). The fact is that Canadian chartered banks are accountable to their shareholders, and their risk tolerance has lessened as a result of the global economic meltdown. Although some in the banking industry would say that this is beginning to ease up, the banks are now even less likely to lend on future cash flow from operations, rather than on current physical assets.

The Business Development Bank of Canada (BDC) has filled the void left by the Canadian chartered banks by taking on perceived higher-risk clients with more of a longer-term financing model. Their focus is on lending, financing, and venture capital for small- and medium-sized companies.

Remember that whatever type of bank or lending institution you deal with, choosing a bank is like choosing a new partner for your company: intense discussion and personal introspection are required to find the right fit. Generally speaking, as long as the banking institution has confidence in the future of the company and its owner, it will stand by the business. Even small gas-weighted firms can raise capital in this depressed price environment. There is a lot of private equity waiting on the sidelines, looking for a home in the energy sector. Assuming you have the right management team, a proven track record, and a solid asset mix, private investment can advance your ability to fund and expand operations.

The Cash Conversion Cycle (CCC)

Your cash conversion cycle is how long it takes one dollar invested in your business to return to your bank account—or put another way, it’s the number of days a firm’s cash remains tied up within the operations of the business. If you can optimize (that is, shorten) your CCC, you will free up cash to fund operations and growth.

Some companies, like Dell, have perfected their business model to the degree that they actually have a negative cash conversion cycle. This means that Dell gets paid upfront, prior to actually spending cash on their materials and inventory. Think about the last time you bought a Dell computer online and you’ll know what I mean.

In the energy sector, particularly on the services side, the key performance indicator that gets the least amount of attention—but can provide the largest impact on CCC—is Days Sales Outstanding (DSO). DSO is more than just a firm’s accounts receivables: it’s how quickly an invoice is generated relative to the terms of the agreement or contract. The quicker the invoice is processed, the sooner the cash is in the bank and the less reliance there is on expensive financing options.

The returns here can be significant, and the resulting payoff goes right to the bottom line. A number of the larger suppliers in the energy sector have been successful in cutting their DSO significantly over the last several years.

Mergers, Acquisitions, and Assets

If you are in the enviable position of having enough cash on hand to invest in the business, now is the time to pick up strategic assets and to look for undervalued companies that fit your culture and business model. There are a multitude of great deals to be done for those who properly conduct their due diligence. Growth through mergers and acquisitions can be a very effective way to increase market share and optimize your infrastructure.

The Bottom Line

Gone are the days when energy companies could easily access credit and capital to fund their operations and growth, but banks, private investors, and other financial institutions will always play integral roles in supporting your business success.

If you’re not sure how strong your relationship is with your bankers, then it’s time to invite them out to lunch or to a hockey game. Similarly, your shareholders have expectations that need to be managed, particularly when the value of your company may have taken a nosedive in the last year or so.

At the end of the day, all of them are people like you and me, who are working hard to make a difference. Keep the channels of communication open, because you never know when you’ll need an additional influx of capital to run your business.