The Importance of Liquidity: Liquidity Is King — Not Elvis!

Remember the saying from one of Clint Eastwood’s Dirty Harry movies—“A man has got to know his limitations”.  This applies equally well to the art of economic forecasting.  The art (not science) of economics is useful in forecasting what the predominant risks are facing our national economy and the resulting consequences.  It is not sufficient to say that next year our business economy will grow at a 3% rate and inflation will be 2%.  This is sheer crystal ball gazing and not of much use.  With this in mind, let’s examine our national economy and see why liquidity, both on a professional and personal level, will be king for the next decade at least.

Do you have a metal chain in your house?  Take a look at it.  You will notice all the links are of equal size.  The U.S. economy can, in a way, be represented by the links in a chain.  But, the difference is that the economic links are not of equal size.  In addition, some links are weaker than others.

The biggest link in our national economic chain is the consumer or more explicitly, consumption expenditures.  This link now represents 70% of our Gross Domestic Product (GDP) and dwarfs all the other economic links combined.  This link is also the weakest link in our chain and is the one of most concern.

To put it succinctly, the consumer is tapped-out.  With the direction of interest rates trending higher, Americans can not continue spending money they do not have.  Household borrowing is increasing substantially faster than incomes.  Even though real wages are increasing, the most of the increase is being absorbed by substantially higher medical insurance premiums.  We use to talk about a healthy savings rate in this country.  Now, we have little to none. The most important link in our economic chain is extremely illiquid.  This will have long-term consequences for economic growth and, hence, the ability of companies to maintain their profitability and grow their top-line.  Eventually consumers will have to rebuild their balance sheets and save more and spend less in the margin.

There are some things worse than having a recession, which is, having none at all.  Recessions provide the impetus for both consumers and businesses to rebuild their liquidity.  It is a painful process, but it sets the stage for the next strong upward expansion.  For example, in the early l990 recession the average American household pared their debt by an inflation adjusted $410.  This helped set the stage for the strong expansion in the l990’s.  In the 2001 recession, the average U.S. household added $1,420 to their debt levels.

It is possible for awhile to avoid a business recession through Federal Reserve policy of manipulating interest rates.  But, the price to be paid is high.  The economy can flounder along in a tepid sluggish manner and can easily stumble into a more serious recession.  You are sort of operating in an economic Twilight Zone between growth and stagnation.

Another consideration is the unusual political alliance in Washington.  Democrats and Republicans in Congress disagree on many political matters, but there is one fundamental economic point they do agree on.  They both like to spend increasing amounts of money on programs that can’t be sustained.  Eventually tax rates will go up no matter who is in the White House.

This is unfortunate because large cuts in marginal tax rates is the one thing that can produce both sustained and substantial increases in economic growth.  In the l920’s then Secretary of the Treasury Mellon went through an exhaustive study to determine what top incremental tax rate would maximize income to government yet, also, provide meaningful incentives for individuals to take business risks.  The answer was a top rate of  25%.  This is far lower than the current top rate of 35%.  In addition there were no phase-outs of deductions then based on income levels.  For example, in 2007 for married couples filing jointly, there is a phase out of itemized deductions at a adjusted gross income starting at $156,400.  The net effect is to increase the marginal tax rate above the nominal value.

The question, then, is how do you grow your business in an environment that will be highly competitive and turbulent. The most logical answer is to increase prices of the goods and services your company offers.  Logical– yes, but it is not realistic.  If anything, with the economic environment described above, the market will be dictating downward pressure on prices– not upside. This leaves one other alternative: going after market share.

We have had the mistaken belief in this country that the business future belongs to the big and the mighty.  This is nonsense.  The future belongs to the swift.  The swift are those men and women whose businesses have liquidity  (low debt levels) and are generating sufficient levels of free cash flow to take advantage of opportunities that will be presenting themselves.  Free cash flow is the wherewithal, the stuff, that successful business people can use to innovate new products and services, which along with effective marketing and customer relations can be used to grab market share from your competitors.

Additionally, those businesses that have liquidity and cash flow can also secure market share by lowering prices while still maintaining profitability.  This line of survival thinking falls under the category of guerrilla marketing.  Let’s face it—- it is a jungle out there, and the swift and nimble are the ones who will prosper in this environment.

People tend to make situations more complex than they are are.  This evolves from a tendency in human nature to drift from the simple to the complex.  But, in business it does not have to be this way. If you can focus on building-up the free cash flow in your business (and it wouldn’t hurt your personal life either), you will both increase its value and have a competitive edge in the marketplace.  It is that simple.

Sanford Kahn is a Business Author and Professional Speaker.
For more information on my  programs please contact me at www.businesstrendspeaker.biz/contact-me

My latest book is The Thirteen Great Economic/Business Myths That Dominate Our lives.The book is available on most popular book web sites (amazon.com).