2009-07-11: Foundation of Business Failure: Finance Games
Foundation of Business Failure: Finance Games
Restaurants on the Ropes - Rick Newman (usnews.com)
Other eateries are in a pickle. Fancy restaurants that had long waits a few years ago are now begging for customers and offering sales. Midpriced casual dining outlets are losing customers to cheaper fast-food joints. Even some dollar-menu franchises are suffering if they?re overdependent on mall traffic or clustered in regions where the economy is weakest. A key factor is debt: With sales down everywhere, many companies that borrowed heavily to remodel, expand, or buy other franchises now find that interest payments gobble up a nerve-wracking amount of cash flow.
One of the things they teach you in business school is that well-run companies try to balance their WACC to create the most efficient capital structure for the business. At least, they taught this at Cal State San Bernardino. This is probably true in big businesses, such as the LOOACs that got into money troubles and caused this recession. It is definitely not true for smaller businesses. By this, I mean that the most efficient financial structure for a smaller business is one that is composed mostly of equity investment, with a limited amount of debt financing in the mixture. Then again, watching the shipwreck of the economy caused by risky financing policies in major corporations and banks, one must consider that maybe this is also the best financial structure for larger corporations, too.
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Well-run smaller businesses try to minimize and avoid debt. Certainly, they do not expect to completely avoid the use of debt-financing, but they do recognize that even small amounts of debt dramatically increase the riskiness of their profit streams and endanger their ability to pay their bills and their employees.
US News and World Report tells us about some large restaurant chains that owe money and may have trouble repaying it unless the economy changes in the next few months. The lesson we should learn is that one borrows based on his present expectations, but no one knows what the future will bring. I conclude that there is some benefit from borrowing for expansion or remodeling, but that we have to also watch for the impact if our expectations turn out to be overly optimistic.
There are trends in the general environment that you and I cannot see until they splash upon the beach of public perception. This is what happened to the companies on this list. They borrowed funds for expansion, remodeling, or whatever. Then, the world changed around them, affecting their ability to remain profitable and to generate the cash-flow necessary to service their debts. If these companies, with hundreds or even thousands of outlets and paid expert forecasters, could fail to accurately predict the economic environment of today, it is very likely that you will also fail in that. A wise business-person will seek to reduce borrowing, sometimes even if it means slower expansion or reducing the near-term return to stockholders. (Of course, this also means that well-run businesses should seek to attract more long-term oriented investment instead of short-term "up the stock price" investment, but any sensible person knew that years ago.)
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