The Curvy Road Ahead

The 30 years that I have been a party to American business have included some so-called “black” days on Wall Street, a meltdown of the savings and loan industry, large bank failures, the breakup of a monopoly, manipulation of the silver market, scandals that started congressional investigations, hyper-inflation, stagflation, the fall of countries, recessions and massive failures of government agencies to do their jobs.

But, never the tumult of this September.

Last month, we came to the precipice of a global economic meltdown. One news channel quoted Alan Greenspan as saying, “This is a once-in-a-century event.” It will forever change the way countries govern their public companies, quasi-government businesses and even private companies that may have an impact on the economic well-being of small businesses and consumers.

At this time the full impact on our industry cannot be forecast, but it is safe to make at least two assumptions for which we can and should prepare.

A year ago when the home mortgage crisis was just surfacing, I warned that bank credit for small business would be tightened so that commercial banks could adjust their balance sheets for the lower-quality home mortgage investments they had made. As banks began to scrutinize their policies and procedures for underwriting new loans, they even stopped lending to other commercial and investment banks.

The administration has announced an intervention plan that averted a global economic meltdown. With congressional approval, banks will be allowed to off-load the bad assets and get back to making commercial loans. Thus, the first assumption is that we still have the better part of a year before credit for small business returns to what we called “normal.”

In the absence of credit, there is the prospect of a slowing in the payment cycle of commercial payers, and higher bad debt write-offs. The healthy response for DME providers is to increase the diligence of cash management. Those who run out of cash will have a slim chance of survival. As reimbursement rates decline in 2009 and beyond, the management of cash flow will become more challenging than ever before.

There are two steps to maximize cash flow from operations.

1. Maximize the sustainable growth rate (SGR) of the business There are two parts of the equation. One is retained earnings. Increasing the retained earnings increases SGR. To increase retained earnings, the enterprise must first create earnings, then retain them to finance growth rather than distributing them to shareholders. The crux of increasing earnings is selling more of the products that produce the highest revenue per man-hour consumed. The second part of the SGR equation deals with asset turnover. Assets consume cash, which is exactly what needs to be avoided when credit markets shrink. Accounts receivable are the provider’s cash in the payer’s checking account. Inventory and rental equipment are the provider’s cash on shelves and in patient’s homes. The response from providers should be to accelerate asset turnover. The short story for accelerating asset turnover is to create more revenue per dollar of assets on the balance sheet. Subsets of asset turnover include DSO (days sales outstanding), Inventory Days on Hand and Fixed Asset Turnover.
2. Control sales growth Growth consumes cash. When a company grows faster than its SGR, it will ultimately create a cash shortfall. In an environment where there is an insufficient supply of capital, this can be fatal. Each company has its own SGR that can be calculated. As an industry, we average about 15 percent. As profit margins shrink next year, we can anticipate that the average SGR will, too.

The second assumption is that insurance coverage for DME companies will become more difficult to obtain. When the government bailed out AIG, it almost certainly set in motion congressional scrutiny of the entire insurance industry. What Congress will likely conclude is that the industry is too highly leveraged. The debt-to-equity ratio for the insurance industry is about 15 times what it is for home medical equipment, and 1.5 times what it is for banks.

In order to right the balance sheets, the insurance industry will have to slow its growth and increase its profitability. One of the methods that you can expect to see is that insurers will be more selective about the risks they take. Another is that they will increase premiums. Neither of those bode well for our industry.

The premium increases are more likely to be an irritant than to threaten our survival. However, the underwriting could leave providers scrambling for required insurance coverage, which could threaten a company’s survival.

There should be several months to prepare for this, but preparation should begin now. First, the steps mentioned above also apply to the insurance situation. Second, providers should be sure their balance sheets are in good shape. Managing the same ratios that Medicare uses for competitive bidding applies here, too, because insurers will use them to evaluate the risk.*

Third, acquire all of the coverage you may need in advance. Next year your agent may be limited to the amount of new premium dollars he can write (it happened in the early 1980s), so you may not be able to get the coverage then.

*For more, check out “No Time to Relax” in the September issue of HomeCare, available online at www.homecaremag.com.

Wallace Weeks is founder and president of Weeks Group Inc., a Melbourne, Fla.-based strategy consulting firm. He can be reached at 321/752-4514 or by e-mail at [email protected].