How not to run out of cash in your business
3 different types of measures
2 weeks ago I asked this poll question:
Which startup failure reason should I dissect?
🟩🟩🟩🟩🟩🟩 How to not run out of cash (29)
⬜️⬜️⬜️⬜️⬜️⬜️ To hire or not to hire, that is the question (1)
⬜️⬜️⬜️⬜️⬜️⬜️ What is your ideal “working capital” number? (2)
⬜️⬜️⬜️⬜️⬜️⬜️ Knowing when (and when not) to take on an investor (4)
🟨🟨⬜️⬜️⬜️⬜️ Stop undercharging… X reasons you should increase your price today (11)
🟨⬜️⬜️⬜️⬜️⬜️ Processes for controlling costs in your business (8)
⬜️⬜️⬜️⬜️⬜️⬜️ The cost of an inefficient business (2)
via @beehiiv polls
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Without further ado...
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How not to run out of cash in your business
When I ran the poll asking which article you wanted me to write, “How not to run out of cash” ran away with it. It’s clear, a bunch of y’all are out there running out of cash.
O, you’re not?!?! Well, it’s clear it’s a point of interest.
It’s clear, and unsurprising that:
- Everyone fears running out of cash
- No one “knows” concretely how to not run out of it
You can’t truly understand this skill until you’ve been in a spot that you actually think you might.
During a big growth phase at a previous company, I can tell you… I saw my life pass before my eyes a few times. Why did that happen, you ask?
The sequence of events went like this:
We grew rapidly. Customers had greater than 30 days terms. Revenue was based on employee hours (low margin). Our bank was slow to approve a line of credit increase.
The growth, a function of current customers scaling up and new contract opportunities, all came at once. It was an exciting time, for everyone but myself.
I knew immediately we had to find a way to fund the operation. With payroll being a significant part of our margin, we had to pay employees before we got paid by the customer.
The same day we heard from our customer scaling up, I called the bank. I let them know how urgent the need was and they assured us they’d take care of us.
Their idea of taking care and urgency was different from ours, unfortunately.
What that meant was I had to set out and do some planning.
First, I mapped our cash inflows and outflows for the next 90 days.
Next, I looked at supplier and customer contracts to see where I could “save” or defer payments.
Last, I looked for alternative funding sources.
Conveniently, this aligns well with the 3 types of cash preservation strategies I’m going to outline (fancy that):
Let’s dig in.
Maintenance strategies are the things you do on a daily, weekly, and monthly basis to make sure you never get to the spot where you risk running out of cash.
This is about establishing systems and processes that help you keep an eye on cash inflows and outflows, so you can identify issues well before they become a problem.
Create a cash flow forecast
A cash flow forecast is an essential tool that every business should have. You should know at a glance what your estimated cash movement is for the next 13 weeks.
You can only know this by doing the work and understanding the ins and outs of your cash.
It starts with making predictions about revenue and expenses, then refining is as you go.
I’ve received multiple requests on how to create one of these, so we’ll talk about that soon.
Maintain minimum cash balances
Every business should have at least 2-6 months of operation expenses and debt payments in cash.
Every 3-6 months you should reevaluate this number to make sure you still have enough in the bank.
To evaluate your minimum cash need, look at the following:
- your low cash balance the previous 12 months
- your 12-month average operating expense & debt payments
Adjust these items for any unusual circumstances and come to a monthly number for each. Then, create a range for between 2 and 6 months of cash. Looking at each range, determine your money “floor” and stick to this for your business.
When you go below the floor, you know it’s time to immediately act.
Establish Accounts Receivable procedures
I feel like I’ve been on a kick with this lately, but I’m going to keep beating the drum.
Setting policies and procedures for invoicing and collections can help you avoid a world of hurt.
When cash is tight and money isn’t coming in from customers, it’s frustrating.
By setting up procedures and following them consistently you help increase your cash balances and avoid running out of cash because you didn’t collect.
Implement just-in-time inventory policies
Inventory is tricky, especially with the supply chain issues in the last few years.
If managing a lot of inventory, it’s important to monitor your supplier and stock, as well as set policies for handling reorders.
Inventory can tie up a lot of cash that isn’t easy to get to when things slow down.
These are the actions you take as soon as you see problems on the horizon. They’re reactive because you can take action and get immediate relief.
The most important thing to do is to take action to extend your runway.
Reactive actions would be:
- Revisiting contracts to renegotiate payment terms
- Activitely tracking down accounts receivable
- Slowing down payments to suppliers and vendors
- Reviewing expenses and cutting deeply
- Increasing prices
By utilizing these strategies, businesses can extend their cash runway and provide room for less reactive decisions in the future, like cutting staff.
Proactive cash management is seeking out other, alternative, financing options, such as venture capital or loans.
Which type of proactive cash management you take will depend on the options available to you and the cost of the capital.
There are 2 types of funding: debt funding & equity funding.
Examples of debt funding are:
- Lines of credit
- Customer advances
Debt funding will typically cost you money, as interest is charged or discounts are offered to those offering this source.
This type of funding includes:
- Outside investors
Equity funding will cost you an ownership stake, which means less future cash flow (for you) from the business.
If you, as the owner, have the cash to cover a shortage, you can put money in and avoid seeking outside help.
If a venture/private equity-backed company, understanding “the game” is extremely important. The signals you give and get when raising money can make or break your ability to do so.
I reached out to my good friend, CJ Gustafson, to get his first-hand perspective on when to raise.
CJ said you should raise in 2 scenarios:
- When you have 10 months of runway/cash left
- When your growth rate is accelerating
When raising, you should seek to get 18 months of runway in the bank.
If you’re in that world, I implore you to subscribe to CJ’s newsletter Mostly Metrics.
While we were probably not as close to “running out” as I remember, this day (and days) are still as vivid as if it were yesterday. The fear was real.
And that’s the thing with running out of cash. It’s okay until it’s not. And the “not” is really bad. The not means not being able to pay vendors, employees, or yourself.
This is why it’s so important that we deploy all 3.
What should I write next?
Next week I write how to track and understand cash flow. Tell me what you want to see in 2 weeks.
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