You can have a profitable business and still fail. In fact, the number one reason for business failure is under-capitalization – running out of cash. As most business owners know, profits do not equal cash flow. It takes cash to invest in infrastructure, lay the foundation for future growth, and build capacity. Much of these cash requirements show up on the cash flow statement and balance sheet, but not on the income statement.
There are three sure signs that your business may be heading for a cash crisis:
One: No cash flow projections or cash budget. While many businesses (although not enough by a long shot) plan for revenues and profits, they do not do an adequate job assuring sufficient cash flow. A cash flow statement completes the income statement and balance sheet as the three essential financial management tools for a business. Every business should have a comprehensive cash flow budget that defines how much cash will be available from financing sources and operations, how much will be needed for operations, and how much will be required for non income statement activities such as expansion, infrastructure, investments in inventory, and investments in longer term assets. The business should also understand the sources and uses of cash, and levers to improve cash flow (e.g. decreasing days receivables, increasing payables, improving financing sources and terms, and eliminating unnecessary or unprofitable cash outlays). At the same time, the business coach should challenge these assumptions, because most businesses tend to severely underestimate how much cash flows out of the business, and how long it takes to recover that cash.
Two: Rapid growth. Rapidly growing businesses are much more likely than slower growth businesses to run out of cash. Cash flow needs increase with growth rates. That’s because the business needs to hire new people, increase marketing, invest in production capacity, order more inventory, and make other expenditures to keep up with demand. The smart business owner will slow growth if required in order to balance capacity, cash flow, and demand.
Three: Early stage development. Early stage companies also are more likely to run out of cash. They often receive only partial funding for investors who will provide more cash pending certain milestones. At the same time, most entrepreneurs underestimate the time to cash flow and cash flow required in the business by as much as 100-200% (time and time again!). Owners of early stage companies need to be skilled at finding sources of cash and in projecting cash flow accurately.
Given these three situations, there are four essential lessons for cash flow management:
First, budget cash flow and have continuous conversations about the status of current cash flow, projected needs, any unanticipated cash outlays required, ways to generate additional cash, and ongoing targets.
Second, secure sources of cash well before the cash is needed. Cash comes much less expensively and freely when the business owner doesn’t need it. Once the business owner needs cash, he or she either has to pay a premium or finds that the business metrics don’t justify an investment or loan.
Third, put controls in place to avoid unnecessary uses of cash. The most successful entrepreneurs treat loose change like it weighs as much as manhole covers. The business is more likely to conserve cash if strict controls – including on the CEO – are in place to avoid missing the cash flow plan. For instance, have a clear agreement that expenditures over a certain limit must be discussed by the Board or entire leadership team.
Finally, the business coach can hold the leadership team accountable for managing cash and provide a much-needed objective look at when exceptions to the cash flow budget are appropriate and not.
The bottom line: If you intend to stay in business, do not run out of cash or sources of financing.
