Cash is king. We all know that. When we run out of it, we are done; unless you have an endless supply waiting for you somewhere (which by the way, if you do, I have a few really good ideas I want to run by you for new businesses!). I know we all get it, we need cash, both in our businesses and at home to survive. And hopefully you have an eagle eye on your cash balances each and every day.
Most entrepreneurs I hung around with, even if they claimed to be financially ignorant, could talk about whether they had enough cash to operate, and especially, to make payroll. But the question is, how much cash will you have in two, three and out to six months? What I don’t see most entrepreneurial types doing is gaining a complete understanding of their cash trends.
Fast-growth businesses eat cash, quickly. In fact, truth be told, running out of cash is the single largest cause of failure of small businesses. Over 60% fail because of running out of cash…ouch! I can remember like it was yesterday. January 2004. Our bank balance was $650,000 – nice! Sales were growing – sweet! Profits were growing – icing on the cake! So why did my partners hate the phone call I made telling them we were going to run out of cash by June, AND exceed the limit on our credit line? Because they knew I understood the trends of cash. We had just hit our peak, and for the next 6 months, we were trending downward fast, even though sales and profits were growing—especially because of sales and profits—and the expenses needed to deliver were also growing.
The mistake I see many entrepreneurs make is to focus on today’s cash balance and forget to look at where it is projected to be next month (and ideally, out another five months at least). The blinders are on! The optimistic entrepreneur is making bold decisions simply because they have cash today. Those are a potentially fatal decisions, and statistics show much more than we want to admit. 60% is a large number!
Cash can trend in the opposite direction of revenue and profits, especially if you are on the accrual method of accounting. A novice entrepreneurial leader is satisfied they have cash in the bank today and will continue to grow the business with no thought of what their cash situation will be next month. They keep taking risks consistent with what got them to this point in their business.
A seasoned (or a better way to say it, a hardened) entrepreneur understands and embraces cash trends. He or she is disciplined to forecast their cash balances out for a minimum of six months, whenever possible.
I am perfectly fine with risk, and I know you are too. That’s what we do as entrepreneurs, we take risks and get paid high returns for those risks. All I am asking is for you to graduate to understanding not just daily cash balances, but also forecasted cash trends.
This changes your risk profile from risk to calculated risk. Go back to your math class days, your statistics courses and commit to veering away from the #1 stat that causes business failure – lack of cash.
P.S. To finish the story, we put more money into the business in February 2004 (our bankers loved that we were on top of the business), and we sold our fast-growing business to private equity in 2007, flush with cash from 2004-2007!
If you would like to learn more about this topic, check out The Second Decision: The Qualified entrepreneur, which has a dedicated chapter each for Cash, COGS and Metrics.