How Successful Businesses Create Positive Cash Flow

Successful companies generate positive cash flow through efficient operations and effective marketing. Generating revenue is not like raising funds for a charity–people will not offer you money simply because they agree with what you do. Businesses succeed when they are able to convince buyers that their products/services are superior to and of greater value than the offerings of other providers. Controlling costs is critical; make provisions for unavoidable cost variances and eliminate waste in areas where  costs–or at least overruns–can be avoided. Planning for adequate capital structure is also essential; debt-laden companies cannot achieve the same level of success as companies with enough equity. Being able to bring in sufficient revenues and preventing large amounts from being paid out will lead to positive cash flow.

Effective companies generate positive cash flow consistently. The business is streamlined continually to  narrowly defined core acutely focused on making sales, controlling costs, and structuring capital. Creating and maintaining positive cash flows is a continual goal of any business, and an ongoing reality in profitable ones. The exercise of staying profitable and successful requires more discipline than many executive teams are willing to enforce in their operations. For example, moving inventory in a timely manner is puzzle to many businesses that make products.; however, those who develop a formula for success in this area are well on their way to positive cash flows. Controlling costs, though, is not synonymous with eliminating costs. Eliminating costs in an arbitrary fashion can kill momentum and limit financial flexibility. Capital is a useful tool if its effects are controlled, and businesses able to avoid large debt loads are more consistently profitable.

While positive cash flow may seem like a lofty ideal to some teams, the investment and financial communities consider cash flow a distinguishing barometer of business stability. Companies with favorable cash flows can secure more favorable financing terms and receive more concessions from vendors and subcontract organizations. For example, businesses with positive cash flows can negotiate higher discounts when they are able to pay invoices early. Additionally, they can prepay materials and buy in volume for even steeper discounts. An enterprise that consistently demonstrates that it can cover more than its cost of doing business (as evidenced by positive net income) will rack up profits and retained earnings year after year and attract more customers, since buyers often feel that profitable companies are more likely to survive and meet their needs for the long run. Therefore, positive cash flow should be the goal of every employee in the business. 

One of the most important things to remember when incurring financial obligations that affect your cash flow is to stay within acceptable industry ratios. Most industries have trade organizations that publish benchmarking data to help representative companies do a better job of analyzing how they compare with norms. The analysis should not become an end unto itself, however. Use the data to have productive conversations with your CPA, banker, and investors. Unless you want a very short day in the sun, avoid reliance on debt. To remain financially competitive, choose capital financing sources wisely and do not burden your operations and marketing teams with a weight too heavy to bear.


How Do Successful Businesses Manage Their Finances?

Once the marketing plan has been developed and the product (service) mix defined, successful executive teams develop a financial plan to determine whether their offerings are economically feasible. Such financial considerations as sources of funding, cash availability, and marketing investment need to be evaluated.

Again, no department or manager can operate in a vacuum during this planning process; it is highly likely that staff in the marketing, finance and operations areas will collaborate on the development of plans for their respective areas, as well as on all aspects of an overall business plan. When a new project, product, or service is contemplated, the finance and accounting staff, in conjunction with the business owner(s), head of marketing, and head of operations should evaluate the company’s ability to:

  • get the initiative off the ground,
  • fund it during development and launch, and
  • continue to support it through sales process and beyond.

Successful businesses are always careful to perform all necessary analysis of these three aspects of innovation. They never assume the financial capability to launch a new idea guarantees success; rather, it is understood that the ability to begin a project is of no value if momentum cannot be sustained through the point of post-sale customer service and satisfaction. The cash required to pay overhead and ongoing obligations when no revenues are coming in from the new initiative can put a company into bankruptcy if not anticipated beforehand.

Securing capital sources is another step in sound business financial planning. The timing and amounts of cash infusions are critical considerations within the overall plan. Sometimes, the lure of a large project or contract can cloud judgment. Without adequate preparation for the cash impact of “ramping up” for new scopes of work, sales volume can become a curse. In fact, some businesses become specific in their growth goals so as to not outstrip precious capital reserve allocation guidelines. (This is not to say, however, that financial instruments such as contract financing are not a way to “have one’s cake and eat it too.”)

Making sure that the business has the wherewithal to “scale” to fit customer demand is important. There will invariably be times when the requirements to pay down payables balances will be instituted by lenders or investors. Likewise, receivables balances cannot become too large too quickly without causing alarm as to the liquidity of the business to meet obligations. Creating a working capital account that is adequately funded to weather fluctuations in business volume–in either direction–is wisdom. How one goes about pre-funding it is “science!”

Businesses that plan for their monetary requirements at every stage of innovation will consistently make more money than those that “fly by the seat of their pants.”  Developing financial plans that support marketing and operational plans is essential for profit maximization. The results of this planning are recommendations to either scrap, revise, or move forward speedily with exciting projects that can lead to increased brand awareness, market share, revenues, and profitability. However, one would do well to remember that no going concern has ever gone broke because its executive team did not start a new project. 

Watch Your Burn, Then Take Off!

When entrepreneurs start businesses, one of the last things they want to think about is running out of money. Whether the money is one’s own, that derived from friends and family, angel investors, or the bank, it has to be managed so that cash outflows are balanced by reserves and inflows. The term “Burn rate” is used commonly to describe  negative cash flow in a start-up. It indicates the speed of depletion of invested capital form shareholders. Once the cash reserves are used up, the company will either have to start making a profit, find additional funding, or close down. Venture Capitalists (VCs) are obviously very concerned about burn rates because they don’t want to see their investments wasted.

[Tom Tunguz, of Redpoint Ventures, in his blog, Ex Post Facto, writes the following:]

How does a VC think about your burn rate? First, it’s important to note that every company is different. Second, geography is an important factor. Third, pure consumer companies’ finances will differ dramatically from  e-commerce or SaaS companies. Given all those caveats, I’ve made a table of the rough figures that I expect to see in a company of various stages, immediately after financing.

When I make an investment, my aim is to fund the company to a milestone that enables the company to raise a subsequent round. Such a milestone tends to be achievable in 12 to 14 months. But a startup should raise 18 to 24 months’ capital to ensure some flexibility in case things don’t go according to plan.

A good rule of thumb in Silicon Valley is that every employee costs about $10k per month. By that estimate, a company of 20 people burns $200k for staff plus 25% for overhead, or $250k per month/$3M per year. This is on the richer side of burn rate calculations but given the rate of increase in engineering salaries recently, it may be closer to the norm.

For revenue generating companies, net burn (revenue – expenses) should be kept under $400k – $500k. A company burning more without the immediate prospect of revenue can be a concern because of how quickly these high burn rates reduce runway. Additionally, the company should aim to reach cash flow break even sometime after the Series B, before a Growth round. Again, every company is different, these guidelines are the mental model I’ve built of typical companies who have pitched us and worked with us.

Granted, Silicon Valley is more expensive than many other locales. Similarly, labor rates/salaries that drive the burn rate math are higher than in other regions. Even still, Tunguz makes a good point about the need to raise about 50% more than one expects will be required in terms of time to reach milestones. The “runway” referred to is the total amount of time before the venture crashes and burns due to lack of cash. As your company grows from solopreneur to employing 5+ people, these guidelines should come in handy to successfully manage the enterprise and its valuable cash.

Better Than Dilution & Debt

One of the most interesting websites we’ve discovered recently about entrepreneurs is called Under30CEO. Today the site featured an interview with Trevor Mauch, founder of AutomizeIt and Mach One Media, serial entrepreneur and founder of a few multimillion dollar businesses. Excerpted from the interview is the quoted section below:

One of the things I see a lot of people I’m coming across, they’re making the funding part (of entrepreneurship) out to be a huge deal [when it’s not.] As a great example…this guy was selling his linen [or garment] business services for hotels or whatnot. He bought his equipment for 500 bucks. And this guy bought this equipment, and then he went to the biggest account in town, which is our local hospital and said “what do I have to do to have your business?” (After he heard the answer,) ..he said “okay, I can’t do all of this capacity right now but if you fund $25,000 to get into a facility and to buy our equipment that can service ..what you need, then will accept this bid.”  …The’s like (a) $15,000 – $20,000 dollar a month account! ..The hospital ended up going with this guy and funded the whole growth of his business!

..With two of my different businesses, …we saw what people wanted, and we went out there and pre-sold one of our training programs before it was ever created! We made sure that people wanted it, made sure it’s really quality, and we pre-sold to our customers, and our customers funded that startup.  And same thing with our software company.  We funded that company with our revenues from the publishing company, and same thing we went out there before we were finished. We pre-sold memberships in it and that help us get some cash to start that goal. So yeah definitely don’t look at funding as an obstacle because there’s a lot of different ways to get funding, especially from your customers, and sites like Kickstarter.

(At Kickstarter) anybody can go there and post their project, their business or products whatever their looking at launching. And they raise funds for their business by getting people to “pre-buy” whatever it is. So, I was last week and uhmm there’s this one [business], that was some kind an iPod speaker and so they had a prototype…they sold a prototype and said “that’s what you’re gonna get,” and they had a goal they wanted to raise, I think that one is about $50,000 bucks. And they raised their $50 grand in about 14 days after they started, just from people seeing this idea and jumping pre-buying one of the things from it!! And that’s just a killer model.

So, the moral of the story is…become creative in your approach to funding your business! It’s not necessary to run up exorbitant credit card debt, nor follow the angel-VC-dilution pattern. Mauch started his first business with $600 cash. Stretch your mind–think hard about how you can accomplish your objectives without copying someone else’s success path. You will be so happy you did when it’s your turn to be interviewed.

Tsunami On Hold

In a recent article, “Six Reasons the Tidal Wave of Business Transitions Has NOT Happened,” Wayne Rivers of The Family Business Institute in Raleigh NC suggests why the huge predicted transfer of closely held business ownership and management has not occurred. He writes of delayed retirement, lack of specific vision for retirement, and inability to sell the businesses as key factors. The result is that the outcomes anticipated have been put on hold–but it’s still a question of when and not if.

We concur with Mr. Rivers’ assessment that most businesses are not ready for sale. Some do not generate enough top line revenues; others do not create enough earnings/profits. As we have mentioned in prior posts, a critical part of any business–be it a family-owned one or professional services firm, or any of a myriad of other combinations–is the executive acumen of the team leading the business. If too many decisions are made by to few people, the business is flat out worth less money. Since the person/people selling are planning an exit, what executive prowess exists prior to the sale either will not persist in the near term or soon thereafter. Any buyer studying this phenomenon would have to be wary of buying a controlling position or entire company under these conditions. The buyers, in most cases, do NOT want to manage the company; they want a qualified team in place who can manage it well on their behalf.

When privately held business owners recognize this major hurdle, they can begin to devise a way to leap over it. Often, the advice of a consultant or coach can help in multiple ways. First, by preparing the management team to grow in their authority and decision-making. (The team must, of course, be committed to stay as well.) Secondly, the senior and retiring leaders can be coached to build a new future for themselves that is challenging and rewarding. Finally, a plan can be developed that takes into consideration how to prepare the various stakeholders for the transition to come.

For those who prepare their business systematically for sale, there is better news on the horizon. Private equity groups have money to invest, are paying more than they have in four years, and are looking for opportunities to build a segment presence through roll-ups or narrowly focused portfolios. According to a report last year, 19% of deals were in industrials and chemicals, 18% in services, and 15% in technology, media and telecommunications in the twelve month lookback period.

In the same mergermarket report, private equity executives said that inadequate management reporting was a top problem 47% of the time and management capability limitations 33% of the time. Shore up your management methods! Prepare to ride the tidal wave of interest in buying private companies as an outcome of the hard work you perform to get your leadership team up to speed to lead without you.