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It's a cliché, perhaps, but Cash is king. Few entrepreneurs in fast growth businesses can ignore their cash runway. After all, if you've got hold of a big opportunity, you must push for all it's worth. If you want to beat your competitors and win, you have little choice but to spend as hard as you dare, but how do you manage your cash and manage the risks?

For the entrepreneurs leading businesses aspiring to rapid growth, worrying about cash and spending decisions is what life is all about - I've heard them described as the 3am sweats. The tension is always between committed expenditure now, and uncertain income in the future.

Having a clear picture that's as accurate and up-to-date as possible is essential. I've never understood the temptation some finance directors seem to have to add a little contingency here, a bit more conservatism there, as though this improves the picture. That just confuses.

Time is the most valuable element, and it's vital to see problems far enough ahead to be able to react. A month-end closing balance is not much help if the problem occurs in the middle of the month around payroll or the timing of some other large outgoing. The best way I've found to see cashflow problems in advance, is to keep track of the worst position that could occur each month by using this formula:

[Opening cash at the start of the month] minus [total outgoings in that month] £

This shows what would happen if all expenditure had to go out before any income arrived. As soon as this turns negative, it means that Management must worry about the timing of payments in and out, and this is when the senior decision-makers start to be diverted into crisis management.

A good early warning sign is when free cash declines and starts to be little more than the cost base. This can easily be monitored by tracking the factor below, and often will show an approaching problem as much as four months ahead:

[Opening cash at the start of the month] divided by [total outgoings in that month] %

I've usually found that the problems become serious when this reaches 150% - free cash is equivalent to six weeks costs.

The example below shows these factors in action.  Note that the Closing Balance seems to say that cashflow problems begin in September, while the Worst Case factor shows that serious cash management is necessary two months earlier, in July, and the Cash Cover factor is pointing to developing problems five months before, in April.

These two factors, and a cashflow that an be trusted to be the best view at all times, should deliver good visibility and a framework for decisions about spending. For most businesses, though, the timing of sales and income is the biggest uncertainty, and this was the subject of an earlier blog. (read more...)

29 January, 2011

(c) 2010, 2011 Peter G. Osborn