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by Eric Englund
Recently,
I traveled to Idaho to meet with several customers over a
two-day period. As a surety bond underwriter, I predominantly
deal with small-to-medium sized public works and commercial
contractors. My objectives, for each meeting, were to gain
a better understanding of local market conditions, to see
if a viable business plan was in place for each contractor,
and to determine which clients would survive this vicious
economic downturn. What became crystal clear, as a result
of these meetings, was that financial decisions made during
the economic boom will determine who survives this economic
bust. Let me give you a hint: Paul Krugman, that channeler
of John Maynard Keynes’ muddleheaded ideas, is dead wrong
about savings.
Astute
balance sheet management, in light of our current economic
depression, has been the key to a construction company’s survival.
Strong working
capital, a strong equity base, and low debt are the hallmarks
of a well-managed company – as revealed by its balance sheet.
The most important component within working capital, in my
opinion, is cash. Unlike what I was taught in grad school,
cash is not trash; and my savvy clients know this. Cash is
king and ever more so when construction revenues are dropping
precipitously. Plain and simple, debts, expenses, and payables
are settled in cash. Contractors who run out of cash, and
have dismal prospects for picking up profitable construction
contracts in today’s difficult economic environment, will
fail.
So, do
contractors view a buildup of strong cash balances as savings?
Absolutely. My clients, who manage household finances in a
conservative manner, typically do the same with their respective
construction companies. When I see a contractor’s personal
financial statement revealing low debt and enough cash (savings)
to cover several years worth of living expenses, it is extremely
likely his construction company has strong liquidity and little-to-no
debt as well. Such companies, characteristically, have been
profitable enough to accumulate significant cash holdings
to the point where a large percentage of cash is not used
for funding day-to-day operations. This "excess"
cash is viewed as a rainy-day fund as seasoned contractors
realize construction is risky and cyclical; and a strong cash
position will help a contractor survive unforeseen problems
including a down-cycle in construction.
To this
end, during my recent Idaho trip, I posed this question to
one of my most successful clients: "With a growing number
of contractors struggling or outright failing today, what
did you do differently than such competitors?" To me,
his answer wasn’t rocket science; it was common sense and
music to my ears:
From
2002 through 2007, nearly every contractor in the Treasure
Valley was making good money in such a strong economy. Many
of my competitors basically went crazy and bought extravagant
homes, purchased motor homes, expensive cars, and even built
ritzy office buildings for their companies. While they were
borrowing and spending as if the boom would never end, my
wife and I realized that our company was generating unusually
high profits so we decided to save as much money as possible
in our personal and corporate bank accounts. We knew this
wouldn’t last forever and a day of reckoning would eventually
arrive. Today, we are glad we saved as much as we did because
our doors are still open and we have been able to keep our
core group of employees. We’re in business for the long
haul.
And what
is happening to the contractors who went "crazy"
during the boom years? Well, they are dropping like flies.
I am bearing personal witness to this. Heavy real estate and
equipment debt are now proving to be financially crippling
to numerous contractors. (Be assured that there was a construction
equipment bubble which closely tracked the housing and commercial
real estate bubbles.) With commercial and residential construction
in the tank, competition for public works projects is tremendously
intense. Profit margins, accordingly, are razor thin. Poorly
capitalized contractors are belatedly recognizing cash has
been king all along. Now it is too late for so many contractors
to recover from prior financial mismanagement. When cash holdings
eventually evaporate, thanks to a lack of savings, employees
are terminated and frequently the businesses are shuttered
shortly thereafter. It is a gut-wrenching process to watch.
It is going to get worse as I foresee countless contractors
failing during this coming winter.
There
is a lesson here for Paul Krugman. His Keynesian-induced distaste
for savings is completely misguided. The contractors who borrowed
and spent, spent, spent (corporately and personally) are going
out of business at an accelerating pace. Not a single contractor
spent his way into prosperity. Those contractors who worked
hard, spent wisely, and built up personal and corporate cash
war chests are going to survive this depression. They will
continue to provide good jobs for themselves and for those
fortunate enough to work for such financially conservative
business owners. Saving, not spending, is the key to financial
survival let alone success.
If Paul
Krugman was a businessman and adhered to his own academic
beliefs, be assured his business would go broke.
October
6, 2009
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