Garry Bartecki More distress plus
This month I was hoping to share some positive comments about inflation, supply chain issues, OEM delivery dates, improving sales numbers and margins. Unfortunately, I cannot do that.
I cannot do that because the activities in Europe have changed from what we call a conventional recession (where we were headed before the shooting started in Europe) to a strange recession that will have more bite for a longer-term. Just what we needed.
In addition, word on the street is this recession will become stagflation where prices continue to rise even though economic activity is shrinking.
Conventional recession could last from six months to a year when events turn and it is a start back to business as usual, such as what happened in 2008 and 2009.
Stagflation, on the other hand, is made up of long-term events that keep pushing up pricing even though the economy is in decline. Hence, we can do away with the transitory inflation speak.
The war in Europe, the COVID in China, more supply chain problems, and especially the increase in oil prices will be here long term with little hope that monetary policy changes can produce a soft recovery any time soon.
The long-term phase is the one that bothers me. It bothers me because if dealers and their customers were taking steps to offset the negative impacts of minor interest rate hikes, short-term price increases, and OEM lead time of six to 10 months, hoping that their strategy provides a return to normalcy within a year, that no longer may be a workable solution to the problem.
This situation is no longer a minor change in the business plan and operating budget. Dealing with Stagflation requires a new set of planning skills few managers have had the pleasure of dealing with. Setting time aside to visit this unusual set of circumstances needs to take place ASAP to discuss how this scenario impacts every segment of your business, not to discuss recession but to discuss how you must operate and cash flow when prices are moving into a double-digit range while sales are falling. This is an entirely new ballgame.
There are businesses out there that are capital-efficient or in other words have the flexibility to deal with stagflation because they have pricing power and are not bound by substantial amounts of debt and fixed costs. I wish I could say that an equipment dealer fits into this category, but you do not.
Dealers will have to examine their revenue silos to see where they are making money. Have to pass on costs if they can, and if they cannot consider downsizing the operation or department, also be careful granting credit while stepping up the collection process. Large AR write-offs cannot be tolerated.
After gaining insights about Stagflation your business model may require revisions if you hope to come out the other side of adventure. Challenging decisions may have to be made once your complete stress tests to see if the revised model cash flows. Spend as much time as necessary, using outsiders, if necessary, to do the projections resulting from the changes.
The bottom line here is the need for a higher-than-normal return on equity. You know this. But what process to use to make it happen is another story.
Return on equity means having control of the balance sheet and operating margins. And one way to find out what yours looks like is to use MHEDA’s Return on Investment Calculation found in the Disc Report.
Remember this:
Profit Margin X Asset Turnover = Return on Assets x Financial Leverage = Return on Equity.
The definitions can be found in the report.
The Profit Margin deals with pricing and cost controls. The inability to pass on the cost increases means cost reductions are in order.
Asset Turnover is where the rubber meets the road. Asset costs are increasing while sales are decreasing. Something has to give sooner rather than later.
Financial Leverage works as long as you can cover the debt covenants and debt service. Keep in mind that more costly inventory will require additional financing.
In other words, Stagflation financials will look nothing like you normally expect. They will return to historical levels at some point, but in the meantime will look uncoordinated and require special and consistent management review.
This process will be something like ZERO-BASED BUDGETING where you “start” the business from scratch and in the process find ways to reduce costs and increase cash flow.
Financial gurus, I follow believe stagflation is in the cards because energy and food costs will stick around for quite some time. It cannot hurt to plan accordingly. If nothing else, you will have a more capital-efficient company earning higher than average returns.
About the Columnist:
Garry Bartecki is a CPA MBA with GB Financial Services LLC and a Wholesaler columnist since August 1993. E-mail [email protected] to contact Garry.
