ES-II: Cash-Cash-Cash

The most important Mantra for a Startup

Many entrepreneurs in India come from a technical background, but lack experience in managing an organisation, specially its cash-flow. Normally enthralled with their exciting 'ideas', entrepreneurs are certain that these will make their company great. They believe that their ideas are so strong that investors will always put in money as and when required. They often do not appreciate the value of money or the risk investors taken by the investors. Many founders do not know how to make the best use of the invested funds and feel no obligation in managing the invested money well. Often, they have a negative view that the investors are only interested in returns and their marvellous idea is worth the investment. Founders seldom work to maximise the probability for investors to get a decent return in the long run. Moreover, they rarely know how to manage cash-in-hand and maintain a cash-flow, so that the company can be prepared for a long haul. It is this mistake that often jeopardises the venture, no matter how good the idea is. When startup runs out of funds, founder(s) sometime blame the investor community for not continuing to support them.

''Cash-Cash-Cash'' should therefore be the mantra for any startup. They need to monitor the company finance and the cashflow month after month (or I will even say every fortnight). Here, I will begin by discussing how to manage the cash-flow. In the upcoming blogs, I will examine other aspects of finance, including product-margins, profit & loss statement and balance sheet.

Startups' Cash Planning - eighteen month forward plan

Managing cash-flow should always be at the back of an entrepreneur’s mind, continuously reflecting upon:
- What is the company's liquid cash balance [1] at the beginning of the month? 
- What is the cash-outflow expected for the current month (should capture all expenses for the month, including salaries, rent & utilities, cost of material purchased, R&D expenses, any tax payable and other miscellaneous expenses)? 
- What is the cash-inflow (if any) expected for the current month (as investment, borrowing or revenue from sale of services/goods)?
- Equally important will be to consider the probability of expected cash-inflow to be converted to actuals. Based on this, what is the likely cash-balance at the end of the month [2]? 

Startup cash planning should not be limited to current month, but extended to the next quarter and further fifteen months. This eighteen-months forward planning, however crude the estimates, is a must for a startup CEO/CFO [3]. At the end of the month, with the actual outflow-inflow noted and cash-balance computed, one should note the difference between projected and actual numbers. One needs to reflect upon, why and where one’s estimates went wrong and learn from it. Every month, the plan for next month, quarter and fifteen months may be revised, also reflecting upon the need for changes and learn from it. For example, whenever company expenses increase due to new unplanned hires [4], the impact on cash-flow needs to be understood. Similarly, the impact on cash-flow due to unplanned purchase of an equipment [5] needs to be evaluated. Any strong need to increase company expenses must be balanced with its impact on the number of months of survival left for the startup. For example, renting vs buying equipment needs to be evaluated from cash-flow perspective.

Reflecting upon cash-flow and probability of cash-inflows and outflows in the following months is a matter of life and death for a startup. Several ‘what-if’ questions need to be asked. One should figure out how and when to cut expenses if the projected inflows are not materializing, based on triggers built into the projected cash-flow. Ideally this should be discussed amongst the leadership team, with each member being aware of all the ‘what-ifs’. It is important to get buy-ins of the complete leadership team. Very often, when the company faces cash difficulties, differences arise among the leadership team that may result in severe tension. Of course, the cash-flow should be discussed in detail with mentors and company board.

Failure to pay regular attention to cash planning almost always leads to a crisis. Suddenly, a startup may realise that it has just enough cash left to meet expenses for two months. Since salary dominates startup expenses, one may not have enough money to even pay employees. The company will be in crisis, with perhaps very little time left for correction. A company, which was perceived to be doing well a year back may now be in doldrums. In such situations stress develops, affecting the bond and trust among the leadership team (often the founders); soon they start to blame each other and may even part ways. This adds to the tension within the company, impacting the ability of founders to raise new funds to survive and negotiate better valuation with investors for the equity.

Therefore, planning and attention to cash-flow is of utmost importance for a company. Startups succeed only if they are prepared for a long haul. There is no formula for quick success. Very often, a startup gets some early funds (either as a grant or loan through an incubator) or some early orders due to a mentor or well-wisher. Although these early funds give startups the initial foundation to grow, it is precisely at this stage that many first-time entrepreneurs make mistakes. In fact, a large first-time inflow misleads the founders to believe that their venture is now successful. Expenses start to mount, very often without any cashflow planning [6], with founders confident that funds will always be available. Even if they do other things right, the startup may not have progressed enough to attract further funding. An easy first round funding deludes them into believing that their “great idea” has won and funds will always be available.

It is precisely for this reason that forward cash-flow planning is a must for startups. They need to estimate the probability of any inflows over the next eighteen months. The ‘what-ifs’ need to be planned.

There are entrepreneurs in the West, who sometime do not care to manage their cash-flow carefully or attempt to spend time in estimating future inflows and outflows accurately. They bet on more money (investment) to keep coming. If their projection for fresh inflows do not materialise after the first round of funding, they would be ready to shut-down the company as quickly as they had formed it. They realise that either they have made a mistake in managing the startup, or they have failed to sell it to the investors / market that they indeed have a great product / service. While it would hurt them, they are prepared for this eventuality. They do not prolong it and are able to move on. Whereas first-time entrepreneurs, especially in India, are not prepared for such an eventuality. If the company closes, they are broken, and it takes a long time for them to recover. The early inflow was a show of confidence by the investors in them and they had messed up the opportunity. It takes a long time for them to figure out the mistakes they made and they would blame others - either colleagues in the leadership team or investors/mentors or sometimes the society (that it does not appreciate the great things that they were doing) or the market. All this “blaming the world” does not help them.  

The forward cash-flow planning can reduce the risk of such an eventuality. The leadership team is likely to recognise the risk early and carry out corrections in time in concurrence with all the stakeholders (leadership team, investors, mentors, those who have helped them by giving some early orders).

To summarise, a startup should clearly figure out their current cash balance and projected cash-flow for about a year and half at the beginning of each month. If the company is hoping to get investment in the coming months, they can incorporate that in the cash-flow plan. But they should also prepare a plan B, just in case the investment does not materialise or gets delayed. Similarly, a contingency plan needs to be in place to address delays in expected orders. Tracking cash-flow is a matter of life and death for a startup.

No wonder the saying goes, "Top-line is vanity, Bottom-line is sanity & Cash is reality"

Summary 

* Cash-flow statement is built using all cash that comes into and goes out of the company and the liquid cash [1] it has as well as all investments made (investments may not be fully or immediately realizable).
* Cash flow planning and forecasting (at least for next 18 months) is key to lowering financial stress. 

* A company (founders) must prepare a contingency plan in case the planned inflows do not actualize or outflows exceed budgeted expenses. This has to be an ongoing exercise, carried out by senior management/founders, with plans/forecasts revised based on actual cash movements. 

* Do not use 'early investments and revenue' as benchmark for company success, instead treat it as a foundation on which to build a sustainable (revenue positive) company. 

_____________________________

[1] Liquid cash-balance is the cash on hand that a company can  readily use, and includes the amount of money available in its bank's current accounts.
[2] As discussed later here and in subsequent blogs, a company needs a contingency plan in case the planned cash inflow does not materialise or cash outflow exceeds budget. 
[3] Start-ups may not have a qualified Chief Financial Officer (CFO) at early stage. One should, however, engage a financial expert on part- time basis to get the handle on cash-flow planning.
[4] A company needs to ensure that the salaries are paid on time, whatever the cash constraints, in order to attract and retain the right talent. Once the confidence of the employee is lost, it is tough to get it back and retain good talent.
[5] An equipment purchase would not impact the profitability of a start-up immediately (as the amount is amortised over many years, as discussed later), but it has immediate impact on cash flow. Therefore, the founder(s) have to choose between buying or leasing an equipment appropriately.
[6] Sometime the startup goes on hiring spree hoping everything is set. It is important to note that hiring is a committed cost and it is crucial to take that decision only if one sees full visibility of cash flow. It might also be prudent to look for freelancer subject-experts or firms to which its non-core work can be out-sourced, so that if there is a stress in the cash flow, the same can be stopped.