“It’s just a flesh wound!” – How critical is cash flow?

Understanding Cash flow and its impact on the growth of a business can be challenging for anyone, especially first-time entrepreneurs. It is often taken for granted that cash flow is the lifeblood of any business. Overconfidence and a refusal to give up are common traits attributed to entrepreneurs, so it should come as no surprise that they refuse to cut-costs and right-size their business when cash gets tight.

“Every time we start a project, we open a wound in the company that bleeds cash. Our goal is to close that wound as soon as possible.”

While mimicking cuts to different parts of his body, I listened as the CEO expressed his view of cash and how important it was to the organization to control the outflow of cash. As he spoke, I could not help but think of the Black Knight from the film Monty Python and the Holy Grail. How many “flesh wounds” was this CEO willing to allow before limiting new projects?

Early-stage entrepreneurs who drive forward without the leadership of a CFO can find themselves frustrated by controllers or bookkeepers who report on cash deficiencies after the fact, when it is too late. I have experienced and heard countless stories of entrepreneurs who continued to spend through their available cash, confident that pitched investors would come through with much needed funding (a “pitched” investor is someone who has heard the company’s fund raising pitch and expressed some interest in investing).

In one scenario, a group of investors were “interested”, but they wanted to be the last money in to finish out the round. When asked why, their response was “we tend to come across companies who get ahead of their operating plan while falling behind on their fund raising plan, so we prefer to invest when the two are aligned.” Over the next few months, the company did just that. Eager to show growth to pitched investors who were on the fence, the team executed against its full marketing plan even though only 50% of the funding had been received. As liabilities to vendors increased, investors on the sideline became wary that their funds would be used to pay past debts and decided not to invest.

Do entrepreneurs who are busy raising money, selling their product, and running a company have enough time to understand the complexity of cash and its impact on their business? In 2001, the Harvard Business Review printed an article titled “How Fast Can Your Company Afford to Grow?” The article provides great insight on translating your theoretical cash cycle into a self-financeable growth (SFG) rate. To grow faster, you require cash. Grow slower than your SFG rate and you generate cash. It is a useful framework that can provide macro insight into your operations, but actual implementation in cash management and day-to-day tactical decisions is often cumbersome and impractical.

It can be challenging for non-accountants to make the translation from accrual basis accounting to cash basis and back. Even some accountants look at an indirect cash flow statement and get dizzy. And to top it off, accounting software cannot provide a view into cash requirements if you fall behind with your vendors or if your customers pay at unpredictable rates. These challenges contribute to the fact that standard financial statements and accounting packages have deficiencies when it comes to managing cash.

The best approach for managing cash through challenging times is a weekly cash forecast that is updated and discussed regularly. Talking in terms of collections and disbursements can get confusing when translated back to GAAP financials, but most entrepreneurs will want to see a translation between the two, so it’s best to plan on it no matter how non-sensical the request may seem. Make the cash forecast simple and quick to generate – discussing last week’s cash after Wednesday is a waste of time. There are plenty of templates out there (google “weekly cash forecast template”). Plan on reviewing a few of them and picking the one that easily pairs with your accounting system and how the CEO looks at the business.

As the HBR article highlights, an important lesson about managing cash flow is to understand your cash cycle and its impact on growth. Do not assume that more sales will reduce your cash requirement. The cash requirements of growth and turnaround scenarios can be very similar. In both situations, an infusion of cash is required to meet the next production and sales milestones. It seems logical to cut costs in a turnaround situation, but cutting costs when you are trying to grow is counter-intuitive. In both situations, discipline and communication is key in managing cash flow. Every company needs to be the right size for the cash available, whether it is growing or not.

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