Cost-cutting can mask a company’s declining revenues

General Electric’s tumble should remind companies of the importance of cash flow.

James McCusker

James McCusker

Measured in Wall Street terms, General Electric’s meltdown is nearly complete. In 2008 the company had a market value of $840 billion and was the darling of the Dow. By November 2018, the once dominant firm’s valuation had dropped to $175 billion, and it had been jettisoned from the Dow Jones Industrial average.

What happened? Or, as one business magazine headline screamed, “What the H— Happened at GE?”

The recent history of GE reads like something out of Greek mythology where everything it touched, from milk to ambrosia, turned sour. Every investment, every effort to right the GE ship seemed to make things worse. Investors and stockholders lost confidence in GE’s management and even the company’s CEO has said the firm’s parts might now be worth more than the whole.

Clearly there has been a management failure of colossal proportions. What is less clear is whether there is anything useful that we can learn from the GE story. Few of us will ever manage a business of GE’s size and diversity. But one of its problems, cash flow, is replicated quite often in smaller companies.

How did a gigantic, successful business like GE, known worldwide for the quality of its consumer and industrial products and a CEO that was lionized by Wall Street, get itself into cash flow problems?

The simplest answer is that GE management did not realize that it had a cash flow problem until quite late, and by then it had been embedded into its corporate structure.

Problem recognition was delayed in part by the fundamental strategy set by former CEO, Jack Welch. Looking analytically at GE’s operations he realized that the company had expanded and diversified without a plan, and had become difficult, if not impossible, to manage effectively.

He devised a simple, yet powerful, plan for slimming down. Each product and service area within GE would be examined and its fate determined by a simple standard: if GE couldn’t be the No. 1 or No. 2 producer in that market, they would sell off their investment and get out.

The plan worked, and because GE was so large and had diversified into so many areas, it worked for years. As the company shed these marginal operations its profit margins and return on investment improved. Stockholders loved it. Everybody loved it.

The only problem did not seem like a problem at all. The selloff of unpromising subsidiaries, though, creates a positive cash flow that could mask a chronic cash flow problem that was building within GE.

In some of the key earnings areas of the company, the time lapse between production costs and payments by the customers could be months and even years. GE management believed, quite rightly, that the most accurate picture of its financial position would offset the costs embedded in these products by recognizing profit before any payment had been received.

There is nothing wrong with this accounting method and certainly taxing authorities often encourage or even require it. And as a going concern, the financial picture it presents is “truer” than the alternative, which could portray a company whose expenses were out of control. Smaller companies commonly experience similar problems of when to recognize profits. There just aren’t as many zeros after their numbers.

The problem at GE was that recognizing the profits in that manner masked the cash flow issues involved in these long-time-lapse products. And when the sale of less-competitive investments brought in a steady flow of cash, it was easy for management to forget that they had an underlying cash flow problem.

It is possible that these combined effects made it easier for management to start believing their own reviews — that it was the best company that ever was, and they were all superb managers. We cannot know that it happened that way, but surely the temptation was there.

What lessons can those of us in smaller companies take away from GE’s history? The first is that you cannot manage your company from your financial statement. You have to manage your cash flow, too. Also — and this can be important — you have to understand your cash flow process well enough to explain it to your bank, because your cash flow may need occasional or regular financing.

The second lesson is that cost cutting is not a winning strategy; it is a survival strategy. And GE’s selling off its less promising investments was not a winning strategy. It was strictly defense, wearing a winning strategy’s jersey. If your company needs to cut costs, then cut costs. But that, by itself, will not bring in a single new customer or an additional dollar of revenue. That takes a winning strategy.

Talk to us

More in Herald Business Journal

Funko warehouse in Everett. (Kevin Clark / The Herald)
Funko to close Everett warehouses, shift work to Arizona

The company headquarters are currently in downtown Everett, but distribution will move to a Phoenix suburb.

FILE - In this Monday, March 1, 2021 file photo, The first Alaska Airlines passenger flight on a Boeing 737-9 Max airplane takes off on a flight to San Diego from Seattle-Tacoma International Airport in Seattle. A Boeing pilot involved in testing the 737 Max jetliner was indicted Thursday, Oct. 14,2021 by a federal grand jury on charges of deceiving safety regulators who were evaluating the plane, which was later involved in two deadly crashes. (AP Photo/Ted S. Warren, File)
Alaska Airlines to add Boeing 737s to the Paine Field fleet

It’s a sign of the growing popularity of flying from Everett. So far, much smaller Embraer E175s have been the rule.

FILE - Washington Attorney General Bob Ferguson talks to reporters, Monday, Aug. 26, 2019, during a news conference in Seattle. In a 5-4 decision Thursday, Jan. 20, 2022, the Washington Supreme Court upheld an $18 million campaign finance penalty against the Consumer Brands Association, formerly known as the Grocery Manufacturers Association. Ferguson sued the group in 2013, alleging that it spent $11 million to oppose a ballot initiative without registering as a political committee or disclosing the source of the money. (AP Photo/Ted S. Warren)
Washington justices uphold $18M fine in GMO-labeling case

Big grocers funneled dark money into a campaign against genetically modified labels on food packaging.

Mara Wiltshire, left, celebrates her first place finish in Mario Cart against her son Miles Jenkins, 7, as Calvin Jenkins, 5, looking on Friday evening at their home in Everett, Washington on January 7, 2022.  (Kevin Clark / The Herald)
Child care’s heightened burden takes parents out of workforce

One Snohomish County mom said she couldn’t return to work “because I didn’t have child care and I wouldn’t be able to afford it.”

In this photo taken May 17, 2017, wine barrels are shown at a vineyard adjacent to the Walla Walla Vintners winery in Walla Walla, Wash. The remote southeastern Washington town of Walla Walla - which used to be best known for sweet onions and as home of the state penitentiary - has now reinvented itself into a center of premium wines and wine tourism. (AP Photo/Nicholas K. Geranios)
More sustainable Washington wines are on the way

Labels will indicate grape growers met guidelines in 9 areas, including water, pest and labor practices.

A sign bearing the corporate logo hangs in the window of a Starbucks open only to take-away customers in this photograph taken Monday, April 26, 2021, in southeast Denver.  Starbucks is no longer requiring its U.S. workers to be vaccinated against COVID-19, reversing a policy it announced earlier this month. The Seattle coffee giant says, Wednesday, Jan. 19, 2022,  it's responding to last week’s ruling by the U.S. Supreme Court.  (AP Photo/David Zalubowski)
Starbucks nixes vaccine mandate after Supreme Court ruling

The move reverses a policy the coffee company announced earlier this month.

Logo for news use featuring the municipality of Stanwood in Snohomish County, Washington. 220118
Regulators OK doubling of composting operation in Stanwood

Lenz Enterprises can now handle 150,000 tons a year. Residents worry odors will be a problem.

Christian Sayre
Everett bar owner arrested again on new sexual assault charges

Christian Sayre, longtime owner of The Anchor Pub, was charged Friday with 10 counts of felony sex offenses.

FILE - Bill Gates speaks during the Global Investment Summit at the Science Museum, London, Tuesday, Oct, 19, 2021. A small city in the top U.S. coal-mining state of Wyoming will be home to a Bill Gates-backed experimental nuclear power project near a coal-fired power plant that will soon close, officials announced Tuesday, Nov. 16, 2021. (Leon Neal/Pool Photo via AP, File)
Microsoft to review workplace harassment, including Bill Gates allegations

One engineer wrote in a letter that she had a sexual relationship with Gates over several years.

Snohomish roofing company fined another $425K for safety violations

Allways Roofing has had at least seven serious injuries on its job sites, according to the state.

ZeroAvia will collaborate with Alaska Air Group, the parent company of Alaska Airlines, to produce a hydrogen-electric powertrain capable of flying 76-seat regional De Havilland Q400 aircraft in excess of 500 nautical miles. (Alaska Airlines)
Hydrogen-powered aircraft company ZeroAvia coming to Everett

It adds to Snohomish County’s growing repertoire of firms focused on flight without petroleum.

Jack Ng, owner of China City, at his restaurant in Mill Creek on Tuesday, Jan. 4, 2022. (Olivia Vanni / The Herald)
Businesses and nonprofits plan to push through COVID in 2022

“You can’t just wait until the fog clears,” says one business owner. Here’s what he and others are planning.