Four Cold, Hard Truths You Need to Know About Cash

Todd Schrock, Advisor with The CEO Advantage

How to Overcome the Unique Challenges of Emerging Businesses (20-100 Employees)  Article #4 in the series.

Avoiding Cash Crises

Will you be in the minority of entrepreneurs who learn these lessons before your future options become limited?

To “survive (the cash crises) and advance,” an entrepreneur must accomplish these 2 priorities:

First, Build the Right Financial Team and System

Second, Learn Well the Cash Truths Most Needed for the Emerging Stage

1.    Profit does not equal cash flow.

Profit is an opinion; cash is a fact. –Anonymous

Most entrepreneurs of smaller companies hyperfocus on cash out of daily necessity. And that small stage of business taught them well that the biggest way to get more cash, at that smaller stage, is to get the next customer. The push for more cash and revenue growth coincide.

That works. Until it doesn’t.

Once moving up to this emerging stage (and often showing their best profits), some entrepreneurs think they have graduated from the need to focus on cash, learning about the marvels (but the limitations) of accrual profit. They often assume that cash and profit will go together just like cash and revenue went together up until now.

The relationship between growth and cash and profit is often not well understood until some big mistakes have been made. Few entrepreneurs of this business size (20-100 employees) avoid learning this lesson the hard way. (Surprisingly, this is often true of even entrepreneurs with a financial background, having been trained in “large company” accounting methods).

Profit is also needed for future capital and credit needs, but a cash focus is far more critical at this time. Cash is your oxygen. Don’t run out.

2.    Credit is not capital.

All cash sources are not created equal. Over-reliance on debt (and especially the wrong types of debt) is a costly mistake. You cannot afford to be distracted by excessive debt payments or the merry-go-round of new borrowings to pay old borrowings while interest expense climbs, draining of you of profit and cash.

But even capital investment from co-owners can cause cash outflow and future profit problems.

Capital investors (co-owners) who need certain rates of return, regular distributions, or scheduled company buyout plans are also not right for you at this stage.

Make sure you have capital sources that fit the unique cash needs of this phase of business. Particularly, if you are experiencing fast or explosive growth, other owners need to realize that you are a growth business with the potential for great longer-term returns if, and likely only if, the company can become well-capitalized at this point.

The capital investment you need is from patient investors who understand this stage. Beware: like wise parents who will not indulgently fund every wish of their children, wise investors for this stage also know that giving you all the investment you desire will not help you learn from the key prioritization lessons of real world constraints.

3.    Growth sucks cash.

At this stage, revenue growth is “easy.” (Seriously, you are beginning to hit the stage where the highest growth rates of businesses almost always occur. Notable exceptions are digital tech companies that can have very high growth rates even after they grow much larger.)

These high growth rates are often the biggest root of the cash problem during this stage. It is not unusual for a company to grow 25%, 50%, 100%, or much faster. Does your ability to regularly generate cash support that level of growth?

Growth sucks cash; fast growth requires lots and lots of cash.

Unless you are tapped into very large amounts of available capital, scaling up profitably is difficult because of the obvious cash needs for expansion of people and capabilities, plus the hidden cash needs for growth (inventories, receivables, bigger customers expecting discounts, and the cost of growing complexity, which often is reflected in declining labor productivity).

The second biggest financial mistake from growth is counting on it to continue ever upward. If you cannot figure out how to pace growth, building your financial capabilities to handle next year’s increase, then the too-often result is the devastation from “next year’s big drop in revenue.”

Growth is fire—beneficial if controlled. Too many emerging company CEOs don’t know what their sustainable growth rate is, financially or otherwise.

Growth is great, as long as you have the cash flow and capital to support it.

I will further discuss the nature of growth in the next article (#5). Then the rippling aftereffects of fast growth on cash will be easier to discern.

“If you had asked me [in about 1990, in the very early days of Dell Computer] whether there is such a thing as a company that’s growing too fast, I probably would have said no. All growth is good and you cannot grow a company too fast. But we learned that this is absolutely not true—there is a level of growth that is not only too fast but dangerous and deadly to a company.”

Michael Dell, 1998 speech to Society of American Business Editors and Writers Technology Conference)

4.    Cash provides an entrepreneurial cushion.

Entrepreneurship is about seeing opportunities, taking risks, learning from mistakes. Cash buys time for the idea to succeed. This is even true of business models that generate positive cash flow, even if not profit (e.g., many of the early years at Amazon). This is also true of capital, which if fairly liquid, is simply accumulated cash.

Most businesses have a seasonality to their revenues, though cash usually operates on a different annual cycle. A good cash model and good cash planning are essential. But are your cash model and capital (accumulated cash) preparing you for the next economic downturn or industry disruption? It is just a matter of time.

(And the best long-term growth companies see downturns as great opportunities to take advantage of the fact that they are not cash-strapped like most of their competitors.)

But the cash-as-cushion concept gets more personal…

As cash gets scarce (or more accurately, during each of those times that cash is scarce), what happens to your time? Your productivity? Your innovation? Your energy for solving the increasing stream of problems? Your decision-making? Your stress? Your sleep? Your personal and family time?

Your spouse could probably paint a picture of “cash flow = life margin” better than you can.

Solid cash flow and great cash planning is needed margin in your life. This margin is a key measure of an entrepreneur’s true freedom.

As with each of these points, much more should be considered here. But this will suffice for now.

Summary: Avoiding Cash Crises

The first deadly distraction focused on reviving your customer focus in order to sharpen your value proposition.

This second deadly distraction, avoiding cash crises, pushes you to sharpen your financial model: specifically, the cash flow, capital, and creditworthiness aspects of your business model. It is the other half of the core strategy work that needs to be nailed at this stage.


Questions for CEO Reflection

  • What is your sustainable growth rate, according to your current financial resources?
  • What would work (and life) be like without cash crises from fast growth?
  • Do you have the necessary financial acumen in-house (or contracted)—education, skillset, experience?
  • Do you have a streamlined financial process that accurately tells you where you are, where you are going and helps each employee to do his or her part to get you there?

© 2017 From the Top, LLC

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