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Just-in-Time Management Doesn’t Work for Cash
By Gary Patterson
Don’t trust anyone who disputes how crucial old-fashioned cashflow is. There's no doubt about it: Cash is the lifeblood of a business. Most companies that fail do so because they can’t manage growth, which often relates to a cash shortage. This article raises some important questions you should ask when you’re thinking of growing your company.
What is a reasonable cashflow reserve?
One of the first questions I ask CEOs is, “How much cash do you need to sleep well at night?” Typically, the answer is a minimum of one month’s operating expenses. The point being that with that amount in reserve, CEOs can focus on other important issues as long as there are no major cash expenditures projected. There is a popular story about how Bill Gates wanted at least six months’ available cash when he was building Microsoft.
Behind the rationale of cash reserve is an understanding of how long it takes to convert assets to cash. Start-ups should plan for six to eight months from when an investor package is deemed complete to the funding (when the check actually clears the bank). Later stage companies with a good earnings history and reliable and loyal customers may need substantially less time if they have strong banking relationships and have kept their financing sources well informed of their financial condition.
What items are (almost) as good as cash?
Most executives don’t want to spend half their time raising cash and half their time living in crisis mode. Profitable customers paying within reasonable timeframes will always be the preferred cash source. Sweep accounts, money market accounts, and marketable securities also earn interest income while still providing almost immediate access to cash. Bankers will be glad to discuss their latest versions of standby lines of credit, asset-based loans and factoring. Listen up – costs and personal guarantees vary dramatically, and you don’t want to be learning about this process when you have little or no time to understand your options.
How can you make better cashflow projections?
Some CFOs – often to the frustration of their CEOs – make the cash projection process seem much harder than it needs to be, and then they use the difficulty argument as an excuse to do minimal or no cash planning. I’ve heard countless stories of hundred-million-dollar companies having minimal or no cash planning process. At a minimum, any company that is in growth mode should start with broad projections of cash receipts and disbursements by major categories, such as collections of receivables, payroll, vendor payments, and regularly scheduled debt or lease payments.
As you begin to develop a projection history, which should include finding reasonable ways to obtain relevant information, you should make the process more detailed by either moving to biweekly or weekly time periods or developing more specific projected cash categories. This requires patience: I recall a situation where I created basic monthly cashflow projections for a company where none previously existed. Instead of testing the system or even asking for weekly projections, the company immediately wanted me to improve the rough projections to predict not just the month the company would run out of money, but the day of the week.
How do cash flow projections work with corporate goals?
Most CEOs will say the value of a business plan is that it helps management focus on the company vision, action plans, and resources needed to meet corporate goals for the timeframe covered, usually at least the next year. Business plans that don’t include cash projections are harder to execute whenever unexpected opportunities or difficulties occur.
For example, substantial growth, new product offerings, or building infrastructure often requires the ability to rapidly commit and spend money. A company that is ill prepared to pursue funding may be forced to guesstimate key operating assumptions such as how long it takes newly hired salespeople to meet their sales quotas. I’ve witnessed bankers embarrass CEOS when they raise this very question: The CEOs don’t seem to have a good answer.
How long a timeframe should projections cover?
This may fly in the face of Thomas Friedman’s worldview as expressed in The World Is Flat, but I contend that five-year projections are still relevant, and in some cases absolutely necessary. To this point, the first year will always be more detailed than subsequent years: In fact, by year five, the assumptions may be considerably less detailed and may only serve an inspirational purpose.
For example, a five-year projection may be required when a Board of Director or prospective investors may want to see a well-articulated vision and a detailed strategy for multiple years to gain an understanding of how the company expects to grow to a hundred million dollars.
At the very least, a company should have at least monthly projections for the next 12 to 24 months on some rolling basis. After that, year three may have quarterly or annual projections: Years four and five may just have annual projections.
For those who now see the usefulness of cash projections, you’re ready to consider some of the steps outlined above. For those who still aren’t convinced of the need for cash projections, may I remind you that when a cash crunch does occur, top management typically is the last salaried personnel to be paid. Is this how you want to run your company? I think not.
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Gary W. Patterson, FiscalDoctor www.FiscalDoctor.com, helps improve corporate growth and profitability, so CEOs and investors sleep better. To obtain a free list of “21 ways to generate cash,” call 781-237-3637 or email patterson.gw@verizon.net.
© 2007 Gary W. Patterson. All rights reserved.
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