It’s the Cashflow, Stupid

Profits are an illusion created by accountants.

You can’t grow your way out of a flawed business model.

Cash is King, Queen, Master of the Universe, and Emperor for Life.

These are mantras I’ve been telling entrepreneurs for years.  Nothing matters more to the life of a business than its cashflow, which is why a good cash forecast is so important to a growing venture.  Derek Baker at Cashboard offers his five reasons cash forecasts are inaccurate.  Great post, via CJ Cornell’s newsletter.

The Beast Comes Roaring Back

The beast is back.  Inflation is roaring, and showing no signs of letting up.  Small business owners concerned about inflation has increased from 74% in Q4 of 2021 to 85% in a recent update of the Metlife/Chamber of Commerce small business index.

Vulnerability of Small Businesses

The problem for smaller businesses is that they are less able to adjust to inflationary pressures.  Small businesses are the weak player when it comes to market power.  Time is your enemy right now, as inflation is raging at levels we have not seen in decades.

If you have big suppliers or customers, they can tie your hands.  Your costs go up, but you are unable to pass along these costs with higher prices quickly enough to keep up with the inflationary squeeze.

An additional worry is that we have a weak economy with inflation — this is called stagflation.  In this scenario, customers begin to sit on their hands.  When you raise prices they either buy less from you or even decide not to buy at all.  Consumers go out to eat less often and when they do, they buy less expensive meals.  They travel less and choose cheaper options.  They postpone buying new goods.  They also postpone maintenance on our big investments, such as houses, cars, and appliances.

Employee costs were already on the rise due to recent labor shortages, but now will likely accelerate as a result to their own challenges with inflation in their everyday lives.

What to do?

When inflation heats up even a little, be aggressive with frequent small price increases rather than waiting and trying to catch up at
some point with one big jump
. Don’t let yourself get behind, as small businesses can almost never play catch-up if the delay price increases.

This can be tough to implement for some businesses, particularly if you publicly list your prices.  For example, it can get very costly to print up new menus each month for a restaurant owner who wants to follow this strategy.

But be vigilant.  Customers are less likely to pay attention to price increases if they are small, so it is essential to find creative ways to communicate your pricing to allow you to implement this strategy during inflationary times.  For example, a restaurant may use menu inserts that can inexpensively be replaced.  This was actually very commonly used in restaurants during the 1970s and 1980s when we had high inflation.

In addition, prudent management of finances can help a business survive inflation:

  • Find ways to cut expenses without impacting the core value offered to customers.
  • Keep overhead low.
  • Build cash reserves to buffer short term price increases that precede your ability to get higher prices from your customers.  I know this sounds contrary to the investment advice we are now hearing about holding cash during inflation.  Don’t think of this cash as investment — it is your lever to hold back the rising tide of inflation.  Think of it as an internal line of credit to hold off the impacts of inflation.
  • Watch your margins carefully. Worry about growing profits, not sales.
  • Don’t lock into long-term contracts that have narrow margins with large customers.
  • Pay down variable interest loans ASAP, especially now that interest rates are temporarily relatively low. As soon as inflation heats up, interest rates will continue to rise.  And given the stubbornness that the Fed is now showing with interest rates, we may soon see huge spikes in rates over just a few quarters as inflation takes hold.

Expand Your Dashboard

A financial dashboard is an important tool for business entrepreneurs.  The dashboard provides a quick overview of critical metrics that summarize the health of a business.

Standard ratios derived from financial statements serve as the foundation of most dashboards.   However, relying only on financial statement data means the entrepreneur is managing the business using numbers based on past performance.

Lessons from a Parking Lot

Many years ago, an entrepreneurship professor shared an exercise he used with students to teach them the limitations of relying only on historic data in their financial dashboards.

He would have his students meet him in a commuter parking lot on campus on a Saturday morning (when the lot was empty).  When they arrived, there was their professor standing next to an old car.

The professor set up a simple course for the students to drive using orange cones.  When the first student got into the car, he realized that the professor had blacked-out the front windshield and side windows.  He was told he must drive the assigned course going forward.

“But I can’t see where I’m going!?”

“You can only use your rearview mirror,” said the professor.

The result was hilarious.  Student after student careened through the parking lot,  driving over cones along their path.  Most thought their professor had gone mad.

Eventually, one of the students would understand the point of the lesson.

“This has to do with financial dashboards, doesn’t it.  We don’t know where we are going because we can only see where we’ve been!”

Lesson learned.

Finding Ways to See Where the Business is Headed

Although I have never actually used this exercise with entrepreneurs I work with, I do often share this story.  I challenge entrepreneurs to find ways to “tear away the black paper” so they can see the road ahead for their businesses.

I give them an example from our healthcare business.  We monitored various metrics related to inquiries and referrals, which proved to be good predictors of future revenues and helped us time the hiring of new staff more effectively.

My rule of thumb is that no more than half of the metrics on a financial dashboard should come from historic financial statement data.  The rest should be specific numbers for the business that indicate where it is headed.

Pitching Investors in the Post-COVID World

Image by Engin Akyurt from Pixabay

Pitching to investors has always been like playing whack-a-mole.   Connecting with the right investor at the right time can be quite tricky.

Now add all the impacts from COVID-19.  Angel investors all but disappeared in the second quarter amid he pandemic chaos.  Venture capital firms became much more cautious and conservative in their funding, trying to mitigate their risk amid almost infinite uncertainty.  More than we have seen in many years, traditional savings skyrocketed as both people and companies fled to cash for financial security.

Many angels who were still investing focused on shoring up companies already in their portfolios with additional capital.

Bright Spots Emerged

Toward the latter half of 2020 and moving into 2021, certain segments emerged as investor favorites.  HealthTech, FinTech, CleanTech, EdTech, and eCommerce are seeing a continued increase in deal flow.  The success of Zoom is making deals that offer better efficiency in business-to-business transactions a new focus of investors, as well.  Deals with strong elements of “sustainability” in the business model are seeing increased attention.

However, overall it seems that investors are moving from hot industries and industry sectors, to a much more targeted form of investing.  As the world is disrupted from COVID and the economic crisis, investors are now focusing on a broader range of deals that focus on specific problems arising from the sudden changes in our world. Investors are seeking opportunities that fit what they see as the “new normal.”

Even if it takes a bit of pitching gymnastics, try to highlight any COVID overlay in your business.

Zoom Becomes the New Investment Marketplace

And then there is Zoom….

The events of 2020 brought an abrupt end to localized start-up pitch events.  Gone are the days of live Demo Days.  The ritual of making the rounds from VC board room to VC board room to VC board room are no longer happening.  Gone are the massive investment conferences.  Everything is now on Zoom.

The entrepreneurship world quickly adapted to the new normal of raising funding.  It had to happen, even with COVID, as entrepreneurs still need funding and angels are still looking for fund deals.

Inboxes now fill up with Eventbrite invitations to Zoom pitch events.  Meetup groups now facilitate bringing together investors and entrepreneurs via Zoom.  No more standing in front of a room full of investors and entrepreneurs.  Now entrepreneurs pitch into the little green dot on their computer.

Just as there was an unwritten set of rules, expectations, and norms for live pitching, we now are seeing a consensus on Zoom pitching protocol take form.

Pitching on Zoom

Some things about pitching have not changed.  You need to be compelling and concise, as you only have the first few minutes to connect on a pitch.  You need to look and act the part.  Dress well; business casual is generally the norm.  Since you no longer have body language to communicate your confidence and enthusiasm, you need to show this through your voice.

Here are a few tips specific to Zoom pitches I have been hearing from both experienced entrepreneurs and angel investors:

  • Make sure you have good lighting.  Natural light is best.  Avoid any back lighting that may come from windows and bright lights.
  • Make sure you have a strong Internet signal and have a backup plan.
  • Technology matters.  Invest in a high quality webcam if yours on your computer is not very good.  The same goes for your mic.  When recording classes for my university students this past summer I was blown away by how much better the video and audio were when I upgraded from my 2015 MacBook Pro to a 2019 model.  I went back and re-recorded all the lectures I had done on my “old” MacBook Pro.  It made that much of a difference!
  • Calm yourself before you get on Zoom.  Most of us do this before a live pitch, but forget how important it is to be “centered” when hopping on Zoom for a pitch.
  • Don’t pitch continuously for more than about 5 minutes at a time.  Break your pitch up and go off of screen share to answer questions and to help keep them engaged.

Pitch Deck 2.0

Even the pitch deck has evolved post COVID.  You should have two versions of the same pitch deck prepared.

First, entrepreneurs still need to prepare a traditional pitch deck for live pitches on Zoom.

The second is what is being called an investor pitch deck, an annotated pitch deck, or a stand-alone pitch deck (there is still no consensus on the preferred term).  It should be organized exactly like the deck used for your live pitches, except that most of the slides will be split in two. The one side includes the same graphics used in the oral pitch. The other side includes a short narrative including what you would be saying about that slide during a live pitch.

Use the widescreen format for your deck to make plenty of room for the two sides.  There should be no more than 150 words per narrative section on each slide on the narrative side, with the ideal word count being about 50-100 words.  There is no need to include the narrative side text on slides which are self-explanatory, such as financial summaries, timelines, and so forth.  The split between the two sides should be about 40% for narrative, and 60% for the graphic side.

This is the version of the deck you want to send out to investors who want to preview your deal before meeting with you over Zoom.  Think of it as an executive summary of your business plan with pictures.

The Good News into 2021

Deal flow is increasing as we enter into 2021.  The strong market on Wall Street and cheap capital has buoyed investor confidence and their portfolios.  We are seeing more angels get back into seed investing, which is outstanding news for startups!

Unless COVID takes a nasty turn for the worse (what John Mauldin calls the “gripping hand” of the economy), things are looking up for a better year for startup entrepreneurs.

Do You Really Need a CFO?

Image by Oliver Menyhart from Pixabay

“Maybe it’s time for you to get a Controller.”

I have said that to entrepreneurs more than once over the past few months.  In every case, all of these companies had already brought in a person designated as CFO (Chief Financial Officer) to lead the financial aspects of their company.  And in every case, that was the wrong type of person to hire for the specific needs of these companies.

What Should be Your First Hire?

Entrepreneurs who experience significant growth in their business may eventually hear this advice, be it from their CPA, their banker, or other entrepreneurs. Financial management in a growing business can become strained.  Eventually, the time will come when the entrepreneur needs to upgradecertain members of the team.

The first instinct of most entrepreneurs seems to be to hire a CFO.  In some cases this may be the right choice, but in many situations a controller or even a senior level bookkeeper might be what is really needed.

Let’s assume what you need to get done is the following:

– Keeps accurate records of financial transactions and also creates basic financial statements (Income Statement and Balance Sheet) using accounting software.

– Performs basic accounts payable management — makes sure bills get paid and records these entries into the accounting system.

– Performs basic accounts receivable management — if the business has to send invoices to customers to receive payment, sends out invoices monthly.

If this is the list of functions that need to be taken care of, you really need a senior level bookkeeper. These are the functions that would be in the job description of an experienced bookkeeper.

What Comes Next?

As a company grows and becomes more financially complicated, a controller adds more horsepower to the financial management team. Depending on the nature of the company, this often happens when the business grows to about $1 million to $3 million in revenues.  (Although, I have seen companies much larger than that get by with a solid bookkeeper and a hands-on outside CPA).

A controller does the following tasks:

– Performs all of the functions of a bookkeeper or supervises the staff that does.

– Creates customized daily, weekly and monthly financial reports to meet the specific needs of a specific business.

– Chooses and maintains financial software.

– Provides basic cash flow management of the business. Major cash flow decisions should still be made by the entrepreneur, however.

Good controllers can pay for their salaries in a growing company.  They do this by helping to create needed financial systems, by keeping costs under control, and by helping to manage cash flow more effectively.

When Do You Need a CFO?

One situation that may require a CFO is if a business must raise a significant amount of outside funding to get off the ground.  This is particularly true if the CEO/founder does not have a strong financial background.

Some businesses may grow to the point that they need a CFO, but this is not true for every business. Many very large organizations don’t have CFOs. If the capital needed for growth must come from complex debt instruments, private equity, or venture capital, a CFO is likely to be an important addition to the leadership team.

A CFO does the following tasks:

– Performs all functions of a Controller or supervises a staff that does these tasks.

– Structures and negotiates complex financing — including both debt and equity.

– Creates complex financial projections to aid in strategic decision making and is an active player in the strategic management of the business.

– Manages banker and other financial relationships for the business.

The Risks of Adding the Wrong Position

One risk of hiring the wrong person is that you end up overpaying for what you really need done.  The typical salary of a controller can often be at least twice as much as the salary of a senior bookkeeper and an experienced CFO earns easily twice as much as a controller.

If a CFO does not have enough work to do in the financial management of the firm, idle hands can become the devil’s workshop.  I have seen CFOs who become overly involved in the strategic decision making that should be the domain of the founders, sometimes creating unnecessary descent and conflict.

The titles “bookkeeper”, “controller” and “CFO” often get tossed around rather loosely. Many entrepreneurs give the title of CFO to people who are not qualified to be one.  They may do this to help bolster the external perception of the company, or simply to offer a nominal reward to someone in place of higher salary. However, to bankers and investors, titles within the financial management of a business have specific meaning.  If you give the title of CFO to someone with the knowledge and qualifications to be a senior bookkeeper, you may destroy the credibility of your business with bankers and investors.

Finding the Right Person

Use your advisors, CPA firm, your banker, and your network of experienced entrepreneurs to determine what type of financial professional your business actually needs.  Once your needs are clearly established, these same people can also help you find a pool of candidates to interview.

Good Debt. Bad Debt.

Image by walkerud97 from Pixabay

Young entrepreneurs generally seem to be reluctant to consider using debt to help finance their businesses.

The reasons they cite are many.  Often, they are concerned that they already have a heavy debt burden due to student loans from college.  Others tell me they watched their parents get deep into debt and don’t want to do the same.  The requirement to sign personal guarantees for business debt terrifies many young entrepreneurs.  More than a few tell me that Dave Ramsey’s anti-debt message shaped their negative perceptions about debt.

When I tell my students that, generally, I prefer debt over equity financing, I see shock on many of their faces.

Bad Debt

There are certainly many instances when taking on debt financing for a business is not a prudent decision.

When I hear of entrepreneurs maxing out credit cards to finance a startup, it sends shivers down my spine.  I know that there are countless stories in entrepreneurship magazines about “heroic” entrepreneurs who went tens of thousands of dollars in debt with credit cards to create incredibly successful businesses.  But for every successful use of credit cards to launch a business, I have seen dozens who end up with failed businesses and mountains of credit card bills that haunt them for years.

Bankers can tell countless stories of business owners with business models that are no longer competitive seeking loans to keep their failing businesses afloat.  Rather than keeping these businesses on life support by continuously pouring money into them, these entrepreneurs need to come to the hard realization that they have come to, what I call, an “Old Yeller” moment.  Sad, but true.

Some debt funds short-term needs for cash, while others fund longer term investments in your business.  However, sometimes we use debt for the wrong purpose.  For example, when I was a young entrepreneur, I used a line of credit to invest in things that were actually tied to growth capital.  A line of credit is meant to fund short-term timing issues with cash flow, such as funding inventory purchases or paying for payroll on a project that will be billed upon completion. I used it for hiring staff and adding new space that would take much longer to generate cash flow. 

Fortunately, I had a good banker who helped coach me on the proper uses of lines of credit. He also provided us with a long-term term loan to use to fund the investments we needed to make in staff and space to grow our company.  I never made that mistake again!

Good Debt

Good debt begins with debt that your business and you can support.  This is how bankers make decisions on making loans.

Bankers always look to multiple means of repayment when making business loans.  The first source of repaying is a healthy business with more than enough cash flow to fund the debt.  The second line of defense to ensure loan repayment is the personal guarantees of business loans by the business owners.  If your financial house is not in order, your chances of getting a loan for your business are diminished.  Finally, bankers will use assets pledged as collateral to pay off business loans, but only as a last resort.

“Bankers only give loans to people who don’t need it,” is a common refrain I hear from small business owners.  The reality is, bankers only give loans to people who they are highly confident can repay those loans.  After all, it is our deposits in the bank that they are using to fund loans.

Bankers understand what makes good debt, and you should understand and follow their criteria for using debt. 

Use With Caution

The requirement of personal guarantees are a sobering aspect of taking on a loan for your business.  Keep in mind, personal guarantees are not only a financial tool used by banks.  It is also a psychological tool.  If you are not confident enough in your business to personally back the loan, then why should the bank?

Another risk with taking business loans is that although your business might be solidly bankable when a loan is made, times can change.  We need to look no further than the thousands of loans that went from safe and solid earlier this year, to being rated as highly at risk for default after pandemic took hold.

When you need to use debt, make it a priority to pay down your business loans as quickly as possibly. Certainly, don’t pay off your loans so aggressively that it hurts your cash flow. However, once you have a good cash position, the next most important goal is to pay off your loans.

The reason I prefer debt to equity is that debt is like a house guest.  When you pay it off, it goes away.  Equity is like adding a new member to your family.  Once you take their money, they are there to stay!

Three Steps to Survival

Image by Joshua Woroniecki from Pixabay

Sadly, many small businesses will fail over the coming weeks.  To increase their company’s chance of survival, there are three critical steps that small business owners must take.

Continue to Slow Down the Outflow

The first step is to continue to find ways to slow down the outflow of cash.  You’ve probably made some initial cuts, but there is always more that can be trimmed.

Look carefully at all expenditures and cut any that do not directly impact your ability to generate revenues, and generate revenues now.  Most entrepreneurs think that many of their expenditures are an investment in their future growth.  We need to recalibrate our thinking. Growth is likely a long way off for most small businesses.

Most economic forecasts are seeing a very slow recovery when it does happen, and there is a lot of uncertainty about when that recovery may begin.  We may see a short-term bounce when things start to open up again, but it may only be temporary.  Be cautious about opening up your spending again!

The V-shaped bounce-back is most likely not going to happen.  Think of cash as a finite resource that needs to be preserved.  This is no time to be timid when it comes to cutting costs!

Anything for a Buck

The second step is to find ways to bring in short-term revenues.  Remember during start-up when you would do anything for a buck?  Get back to that mentality.  Don’t worry about strategy.  Don’t worry that you might send confusing messages to your customers.  They are likely in survival mode, too.  There will be time to get back to honing your strategy later.  Now it is all about cash!

What’s Next?

The third step, once your cash flow is stabilized, is to think about what will be next for your business. Be ready to accept a very different future for your business than you had in mind just a few short weeks ago.

Consumers and businesses will behave very differently over the coming months and even years. Don’t be in denial about what you are seeing.  Savings will become a national obsession in the coming years.  Anytime we have a severe economic shock, people come out of it with a much more conservative approach to managing their money.

The fear of coronavirus may ease once there is a treatment or vaccine, but our collective psyche is likely to be altered for many years.

What we are going through is not just changing our economy, it is changing our culture and our society.  Be ready to think differently about your value proposition and be ready to act boldly!

Cash is King

The moral of the story is simple.  Cash is king!  In fact, cash is king, queen, emperor, and president for life!  This is not a new truism.  However, it is now the most important principle in business.

Small Businesses Seek Cash Flow

Image by Nattanan Kanchanaprat from Pixabay

As the new realities of our coronavirus economy sink in, entrepreneurs struggle as their small businesses seek cash flow.

Kabbage Inc., which helps small businesses with working capital funding, earlier this week launched www.helpsmallbusiness.com. The model is simple, yet potentially powerful, enabling anyone to purchase an online gift certificate from participating small businesses.

Cash Now

The initiative is a way to provide a quick solution for small businesses that seek cash flow. Customers are able to redeem certificates in full after they’re issued or in the future when the crisis has subsided. Kabbage deposits all revenue generated from gift certificate sales via Kabbage Payments as soon as the next business day to participating small businesses.

Participation is Easy

In minutes, any U.S. small business can sign up for free on www.helpsmallbusiness.com to immediately seek financial support through gift certificate purchases from individuals throughout the U.S. Kabbage will also provide businesses a unique URL to easily share their personalized page with customers via text, email, web, social media or print. Consumers can purchase multiple certificates for any amount between $15 and $500. Once customers purchase certificates, Kabbage immediately notifies the small businesses, which can use free technology offered by Kabbage to scan, verify, track and fulfill gift certificates when redeemed.

Together We Stand

“The impact of COVD-19 on small businesses requires the support of a nation,” said Kabbage co-founder and CEO Rob Frohwein. “If there is a local small business that you love, they need your patronage now more than ever. Many businesses are closing and others are seeing reduced demand. The site is a means for the millions of small businesses that employ more than half of all employees in America to continue making sales and to feel your commitment to their long-term success.”

“We encourage everyone to think beyond consumer goods and consider all service providers such as local handymen, lawn care providers, dry cleaners and laundromats; they all need our support,” said Kabbage co-founder and President Kathryn Petralia. “Many weddings, birthdays and vacations are being postponed due to social distancing. Think about the small businesses you would have approached for those activities and purchase certificates to plan for future dates.”

What’s in it for Kabbage?

Kabbage will not profit from its efforts to support small businesses. Kabbage is actively working with organizations in the payments ecosystem to eliminate or significantly reduce any associated transaction fees. Kabbage’s goal is to provide small businesses with a unique solution to generate revenue during this extraordinary time.

When to Implement Budgeting

In the early stages of a new business, entrepreneurs do not pay much attention to budgets.

Financial forecasts that estimate revenues and expenses are part of the business planning process.  But these are really just estimates, since so much is unknown about what will actually happen as the business begins to grow.  Because of this, it is impossible to develop accurate budgets.  Managing cash flow is a week-to-week or even day-to-day challenge that is a reaction to what bills need to get paid first based on what revenues have come in the door. Continue reading When to Implement Budgeting

The Wild West of Crowdfunding

Looks like I have a new example to use in class for legal changes that create new business opportunities.  There are several new entities popping up due to the the growing interest in crowdfunding and the passage of the JOBS Act that will allow crowdfunding to be used for equity investments rather than just donations (the Kickstarter model).  We are also seeing growth in microfinancing, which is another segment of this industry.

One entry into the wild west of crowdfunding is a Nashville-based company InCrowd Capital, founded by Phil Shmerling.  Phil has started writing a blog on crowdfunding that should become a valuable resource for those interested in this budding new industry and those hoping to learn how to become an effective crowdfunder.  Phil is a sharp guy who will surely offer all of us useful information through his blog.

Another site was recently launched is called Seeds.  Seeds is not taking an equity approach to crowdfunding.  Instead, they have established a “game” site that links participants to real entrepreneurs seeking micro loans.  They describe Seeds as “Farmville meets Kiva.”

Here is how they describe how Seeds works:

The Seeds revenue model is three-pronged:

1) We monetize impatience. As you rebuild a citadel in the game, you can either wait hours in real time to complete a level, or use virtual currency to expedite the process. Virtual currency can be purchased with real dollars. Proceeds will be microlent to borrowers.

2) The sale of virtual goods: Within the Seeds virtual world, you can purchase limited edition virtual goods using in-game currency to decorate your world. Proceeds will be reinvested in for-profit microloans.

3) Actively asking players to make microloans to the businesses of their choice.

Thus, we’re merging two multi-billion dollar industries – social gaming and microfinance. We’re taking the profits social games make, and reinvesting it in entrepreneurs for a profit, empowering women and buoying economies (including our own!).

While some are beginning to worry that crowdfunding is just one big train wreck, I think that the evolution of the crowdfunding industry is going to be a fascinating combination of a series of little train wrecks and some amazing successful innovations.

Who is going to win?  Nobody knows, but the market will begin to give us some insights very soon.