In Haiti crisis, a lesson for investors, givers

January 17, 2010

Well-known to businessmen everywhere, but totally under-appreciated by investors, is the concept of working capital, the day-to-day operating cash flow that makes a business run. Turns out the Red Cross has a big working capital problem when it comes to text message donations. From Carrick Mollenkamp (WSJ), Americans pledge millions, but cash flow takes weeks:

Secretary of State Hillary Clinton, CNN, and users of Twitter Inc. have urged people to punch 90999 and then type in the word “HAITI” on their phones to send $10 to the American Red Cross. But the money won’t be routed from most U.S. wireless carriers to relief efforts until cellphone users pay their phone bills.

That could take 30 to 90 days, telecommunications officials estimate, well after the critical initial days in which humanitarian aid organizations are trying to deliver medical supplies, food and water to save injured earthquake victims and help others with their most immediate needs.

To run its operations, the Red Cross needs cash today. But text message donations don’t actually come through until users pay their cell phone bills and carriers pass through the funds. (To be clear, I’m not saying text message donations are a bad thing. They’re an ingenious way for relief organizations to leverage the billing relationships that carriers have with consumers. I gave $10 myself. Still, it provides a good opportunity to discuss cash flow issues that few understand.)

Businesses confront cash flow issues like this every day, yet investors typically ignore them.

Does a business require lots of investment up front to provide its good or service? If so, this can be a big and ongoing operational risk. Every Christmas season, retailers invest in inventory they hope is going to sell. If it doesn’t, they can end up in bankruptcy.

On the other hand, there are businesses that get paid before delivering their good or service. Many subscription businesses get paid up front only to deliver content later.

(The analogy isn’t perfect since the Red Cross doesn’t aim for profits. But it is in the business of disaster relief, which requires a cash investment up front.)

All else equal, it’s better to run a business that gets paid first. Risks that your product doesn’t sell, or that your customers don’t come through with a cash payment, are removed.

Warren Buffett has made his fortune in large part due to astute working capital management. His main business is insurance. He gets paid premiums up front but only pays out if his customers have a claim. In the meantime, he has control of the “float,” which he can invest to generate profits for Berkshire. Writing insurance policies that result in few if any claims has made billions for Berkshire shareholders.

Understanding working capital is also crucial to Buffett’s brand of value investing. If a business must invest capital up front, what is the average return on that capital investment? If the return on capital employed* is high — and the business is simultaneously selling for a cheap valuation — then odds are you’ve identified a stock that will outperform the market. (Joel Greenblatt wrote a best-selling book based on this two-part magic formula.)

And the lesson for charitable givers? Don’t wait for disasters to strike to give money. While the devastation in Haiti is certainly heart-breaking, we shouldn’t think it out of the ordinary. After all, Mother Nature regularly delivers an epic disaster — the Asian Tsunami in 2004, Katrina in 2005, the Sichuan Province earthquake 2008, Haiti 2010.

So consider giving at regular intervals, especially before disasters strike. And not just to the Red Cross. Presumably aid organizations can mobilize more quickly if they have working capital available in advance.

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*There are different ways to calculate return on capital employed. Here’s one way:

Return = annual after-tax operating income = last twelve months operating income * (1 – tax rate)

Capital employed = Accounts receivable + inventories + prepaid expenses + net property, plant and equipment – accounts payable – accrued expenses – deferred revenue

ROCE = Return / Capital Employed. If a company has $100 million of after-tax operating income and $200 million of capital employed, then ROCE is 50%.

Even better than a high ROCE is a business that has negative working capital. For instance, if deferred revenue is really high because a business takes in cash before delivering its good or service, then capital employed is likely negative.

Comments

When a 501c3 has cash on hand they can run into mismanagement of funds easier. It’s they same premise the alcoholics anonymous operates on, we support ourselves and we do not hold on to large sums of money. If we have more then we need we send it to AA headquarters. Who will the red cross send it’s excess money to? Whats a prudent reserve to have on hand to avoid stealing and waste?

Posted by spinmas | Report as abusive
 

The Red Cross will be able to turn a large proportion of the pledged money into cash through short term lines of credit, just like a company can borrow against accounts receivable. That WSJ article was just silliness.

Warren Buffet was set up selling insurance to governments and government employees by his very powerful father. Why on earth do governments need insurance when they have a tax base? Warren Buffet has nothing to teach anyone who is not already rich and powerful.

Posted by GaryD | Report as abusive
 

Re: “To run its operations, the Red Cross needs cash today. But text message donations don’t actually come through until users pay their cell phone bills and carriers pass through the funds,” Via Gloria Huang(of the Red Cross): “Here is a general explanation: the American Red Cross pledges a certain amount of money to go to relief in Haiti immediately, which is supported by existing funds as well as the amount of donations coming in. We then adjust the amount of money pledged partially based on how much is being donated. Basically, your donation is helping the Red Cross back up its pledges. The amazing response we have already received means that we will certainly allocate more money towards relief as we find out more about what is most badly needed. Hope this helps…”
Please be thorough in your research and thoughtful in your wording…this article, in discouraging donations through text messaging, may have cost more than you know.

Posted by R347 | Report as abusive
 

Worried about the investors ? Jornalists are no just a bunch of hypocrites. Shame on you people.

Posted by Thats the world today | Report as abusive
 

Hey, they could invest their excess funds into a CDO.

Posted by JCH | Report as abusive
 

Thanks for the clarification R347. I hope no one reads this blog post as discouraging text message donations. The point I conclude with is that folks should make a habit of giving regularly to the Red Cross. They shouldn’t wait until disasters strike. But of course giving is always better than not giving.

Posted by Rolfe Winkler | Report as abusive
 

Donating via text is not only a lazy fad the way things stand, it also costs more than you know. It’s compromised with back-end inefficiencies and ought to be shunned by all but the most superficial giver jonesing to “care”.

Donating to the American Red Cross is also seldom the best way to help anyone. Mainly, it makes the Red Cross bigger, TBTF and all that…

Although one might think they did from all the mainstream media coverage, American Red Cross does not “own” disaster issues – no more than Al Gore owns the pollution issue, or McDonalds or Monsanto own all your nutritional needs. Time and again it’s been shown that one of these are real go-to people when real problems need tackling.

This does not mean you should not help by donating to Haiti and other causes. Give, but give by other means.

It is right and proper to donate as often as one can, by methods the sincere giver finds effective, transparent and accountable, there being many alternatives. Right now, we are hearing about Red Cross and troops, ad nauseam.

In charitable matters, the ones making the most noise are never going to be the best – a universal experience value.

By texting money to the monolith being touted the loudest right now by the people whose record shows they care the least about anyone other than themselves, however, little or no real good will have been done in the end, as usual.

Posted by The Bell | Report as abusive
 

Why not donate it to the Blue Cross as people behave like animals when it comes to money. Just paying taxes is crippling, let alone 10% to the ‘church’ AND VAT.

This disaster is classic, Amampour of CNN (spelling ?) attacking the poor Head of the UN, exploitative propaganda (‘I was there first’) and finger-pointing.

It should be simple:

1. Re-establish/concoct communications;
2. Re-establish/concoct transport passages;
3. Move the living out of the disaster areas to rural areas;
4. Supply shelter, water and food to THEM, even if it is dropped by air;
5. Let the big boys start cleaning up the mess.

Most important, Natural Selection, let it flow, we need to knock even larger chuncks out of the 7 000 000 000 headcount.

Rolfe, you are becoming a man of the world by mixing in du Pont formulas into such sensitive humanitarian matters, socratic irony by a ‘hypocrite’. What more do you want ?

Posted by Gandhiolfini | Report as abusive
 

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