Where Cash is King, Be a Loyal Subject

Content provided by David Levine of Wireless Environment, a JumpStart Ventures Portfolio Company Want to make a group of MBA students look stupid? Ask them the following question: "Why do early-stage companies fail?" Howard Stevenson asked that to my 2nd-year Entrepreneurial Finance class full of some very bright people. Here is what we answered:

• Poor gross margins
• Wrong business model
• Unrealistic forecasts
• Inability to provide a product of value
• Lack of control over operations
• Guessed wrong about market direction
• Tough competition
• Inability to sell product or service
• Poor solution for the problem
• Hired the wrong people

Every one of us was sure that our answer nailed it and looked for that smile to appear on his face and a "You got it!" response. Instead Professor Stevenson just got more and more agitated. None of us got it, and he was about to teach us one of the most important truths of entrepreneurship. Companies fail for one reason and one reason only, he stated - they run out of cash.  And that truth has driven me since that day. Any of the above mistakes will not help a business, and they will often reduce the cash available - but as long as there is cash in the bank, they can be overcome. I tell my team and I tell potential investors and I tell anyone who will listen - the only way that Wireless Environment fails is if we run out of cash.  So the role of the early-stage leader is to make sure the company does not run out of cash. If you are like us, you don't have the luxury of a CFO, or even a financial analyst. You probably use QuickBooks and have realized that its forecasting abilities are weak. So the role of cash management is critical for the CEO to master. You need a model, you need a philosophy, and you need focus. It is an all-consuming job, and the minute you take your eye off of it to do all of the other things you need to do for survival and growth, the situation changes and throws your model out of whack. Past results differ from your forecast, so you need to adjust the forecast history, and you need to adjust the assumptions. It is analogous to your dirty laundry - unless you are naked and all of your clothes are folded and put away, you are never completely on top of it. There is never a point that you can freeze your forecast and be sure it is accurate.  With this in mind I want to share some thoughts on how Wireless Environment stays on top of our cash situation. This includes the following activities that have proven helpful:

1. Creating a "Cash Predictor" from your financials to help better understand the cash need
2. Understanding your Burn Rate
3. Looking at the P&L and finding where to cut
4. Analyzing and understanding the importance of Gross Margins
5. Using your partners to improve cash flow

1. Creating a Cash Predictor While the P&L and the Balance Sheet get most of the attention, it is the humble Cash Flow Statement (CFS) that is most important for operating an early-stage company. For me it is also the hardest to digest. Too many line items are produced by financial software and it can hide the most important information. The division of items into three sections - Operating, Investing, and Financing - does not organize the data into anything useful for me. I have created a fourth spreadsheet that synthesizes the CFS into a useful tool for understanding the historic uses of cash and predicting future cash flow. It is simple and not all that different from the traditional CFS, but has helped us to forecast cash needs and discuss our cash situation internally, with our board and with investors. Take a look at the Cash Predictor sheet. It is in three sections, but different sections than the traditional CFS. All of the information for this spreadsheet is taken from the P&L and the CFS. Section 1 summarizes the key P&L categories, rather than starting with the Net Income, as a traditional CFS does. Section 2 lists the changes in the Balance Sheet items related to operations. Section 3 lists the changes in the Balance Sheet items related to traditional financing and fund raising. When you look at the structure of this spreadsheet it appears similar to a traditional CFS. However, when we use the tools of analyzing cash needs, this Cash Predictor is much more effective. 2. Know Your Burn Rate With the Cash Predictor, we now know our burn rate both before financing and after financing. I get asked this question weekly, and people want to know that you know your burn rate. With the format of the Cash Predictor, I can say "We are burning through $45,000 per month in operations, and financing it with $28,000 in loans, so our net burn is $17,000. We raised $200,000 in equity, so we have a runway of $200,000/$17,000, or 12 months." We all need to know how long before we run out of cash, and the Cash Predictor helps us get to that number quickly and accurately. I use the line Changes in Equity as a plug to enter the amount we need to raise to avoid running out of cash. 3. Where Can We Cut Costs? The first section of the Cash Predictor summarizes our revenue and expenses. Again it takes a lot of detail from the P&L and turns it into a manageable tool for tracking trends. More detail is always available on the P&L, but for tracking the cash impact of the forecast over the next 12 months, I find this to be superior.  4. The importance of Gross Margin The Cash Predictor highlights the importance of Gross Margin. We should all be able to recite our gross margin and understand what this means. If it is 30%, then that simply means for every dollar of sales, you have $0.30 left to cover overhead. The importance of increasing gross margin goes beyond the scope of this blog post, but the Cash Predictor gives you visibility to the amount you keep on your sales. 5. Opportunities to Improve Your Cash Situation Under the Balance Sheet items are three major opportunities to impact your burn rate: Receivables; Inventory; and Payables. While impacting gross margin can be a longer-term journey, we realized that Receivables, Inventory, and Payables give us the flexibility to immediately improve our cash situation and reduce our burn rate. The key for us has been in partnerships. We have developed the type of relationships with our key customers and vendors that make them recognize the need to help us. A typical initial conversation on cash flow sounds like this: "We all need Wireless Environment to survive. The only way we fail is by running out of cash. How can you help us make sure that we don't run out of cash?" This leads to deferred billing, improved terms, and other creative partnerships. The Cash Predictor showed us how making arrangements with our partners could extend our cash for months. I hope the Cash Predictor can help you forecast your cash needs and evaluate how you can impact your burn rate. Your Cash Flow Statement may work just fine for you. The important take-away is to review your cash forecast weekly and always challenge yourself on how to move the Ending Cash line north. David Levine is President of Wireless Environment, developer of innovative technology and products for battery-backed, grid-shifting LED lighting. Its Mr. Beams product line of bright off-grid LED lights was recently awarded the Seal of Approval from the Handyman Club of America.