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sometimes devastating effect. Companies that could easily have survived
for decades can now topple in what appears to be an instant. You have only
to consider Enron to be convinced of this. The business cycle spins at such
a rate that the average life expectancy of a mature company has reduced
from sixty years to about a dozen years. When disaster strikes it strikes
suddenly and hard, so all managers at every level should have an under-
standing of the financial effects of their actions.

The second finding of the Harvard research is that companies that sur-
vive are those that are frugal with their resources, particularly their finan-
cial resources. Survival is often a matter of timely change and this demands
an approach to money that ensures that when the time comes to make such
a change the cash is there to finance the resources that are needed.

A few definitions

A business needs cash to get going and it surely needs more cash to keep
going. A very small company is often started on no more capital than the
owner’s savings and an overdraft facility. The problem with that is that the
overdraft facility is short-term and can be called in any time and the
owner’s savings are rarely enough to sustain a business through the often
difficult and always expensive early days.

The corporation or limited company is a legal entity separate from the
owners. What it owns it owns, what it owes it owes. Owner’s equity is what
is left of the assets (what the business owns) of a business after lenders and
creditors have been paid what the business owes them. Long-term debt, as
opposed to the overdraft facility is the investment provided, if you are large
or lucky. Long-term finance may be provided through loans from banks,
direct investment by venture capitalists or if you are very large, by deben-
ture stock usually guaranteed against a major asset. Mortgages are another
form of long-term capital. All of these need an actively profitable business
to sustain them. Interest accrues and has to be paid out of profits and ven-
ture capitalists demand a return on their investment.

As a rule of thumb, it is only when additional profits made are more
than sufficient to meet the cost of servicing the loan that borrowing is jus-
tified. In business, loans should only be sought where there is a realistic
chance of increasing profits as a direct result of borrowing.

Gearing is the relationship between the equity capital and long-term
debt. In general the two are kept in balance by the simple mechanism that
lenders usually will not provide more money than the owners have put into
the business. Where the potential is seen to be great, however, lenders
sometimes lose their natural caution and we have the current problems of
a telecommunications industry that is saddled with debts that, in many
cases, it has no practical hope of servicing or of ever repaying other than
through a money-go-round of the sale of assets at inflated prices. Business
owners often wrestle with questions such as these.

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