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May 29, 2009

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I'm no economist. I'm a business owner and a mathematician. Sooner or later the numbers have to add up. And to make that happen spending must be controlled. Many times as a businessman I have seen my companies go from cashflow positive and profitable to cashflow negative and unprofitable. This can occur for at least two reasons:
First: a decline in revenues is not offset by a decline in spending. As an optimistic, entraprenuerial country Americans are true believers that we can solve our problems and good times will follow. So, the tendency is to wait to take action we want to avoid and continue to invest in people, benefits,product development, marketing, etc. To do this in the face of declining revenue we take on debt. It's so easy. No taxes on it and a big chunk of cash to spend immediately. It's such a silent enemy, debt. It comes with interest that increases expenses. It comes with principal payments that increase costs. And, it often comes with taxes because it must be repaid eventually with after tax dollars. So the debt increases future tax payments which may or may not be offset by the way I spent the cash I received.

Second: A more common way this happens is that managers who are anxious to get to the promised land quickly borrow money to invest in marketing, sales and R&D with the belief that they will increase revenues and gain market share by spending $1 to get back $1+ dollars over their unit costs. Early on it works but then something strange happens: a decline in the payback per dollar spent as the market niche matures and the competition responds to the new guy on the block. Blinded by early success the company continues to borrow more and more to build revenues. But the declining marginal return and the added burden of paying back the debt reverses the cashflow of the company from a positive direction to a declining direction. Unwilling to disappoint, management persists in this death spiral.

It's easy to see examples of these two situations in American industry right now. California is a glaring example of a state doing it. And now the country is doing it. Too many organizations are looking for an excuse to borrow (bail me out) rather than make the decisions they have to make. In August of 2008 one of my companies lost it's 4 biggest clients which represented 25% of it's revenue. The banks froze. The investor's froze. And this company which was barely break even on cashflow before it happened was faced with less than 3 month's operating capital. Now management was faced with a quick sale or some tough decisions. While we looked at offers from hungry competitors it was apparent that their view of us was deminished by our aggressive appoach to marketing. Knowing this was depressing the value of our company we decided to change things. We laid off 24% of our staff, we renegotiated many of our vendor contracts, we cut most of our marketing costs, we froze salaries and eliminated bonuses. Only one employee quit. We turned down the offers. In the 9 months that have followed we have gotten cashflow positive, reduced our debt by 25%, and our sales have increased by nearly 25%. Making the hard decisions seem tough. But as a CEO I have learned these lessons over and over. Balancing costs and revenue leads to a stable environment and everything functions better.

Bo makes a good case for the country returning to this basic philosophy. Balance taxes and spending. Manage to it. For the short run some will suffer. But if we don't we will all suffer long term. Recessions, if you let them happen, are capitalism's version of Darwin's Law of Evolution. The strong survive and get better. The weak fade away. In the long run the cleansing is good for America. California has spent it way to bankruptcy and now is begging to take the rest of us with them. In WWII a generation of our relatives paid the price for our benefit. Today we must take the pain for our children's benefit.

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