For an entrepreneur, there is nothing worse than a cash-flow squeeze. Actually, there is one thing: a cash squeeze that occurs while you think business is booming. Yet it happens all the time, one of the many financial mysteries business owners need to solve. In the following pages, you'll meet three owners who grappled with this and other vexing questions and came away understanding that you have to watch a few key financial numbers--and understand what they really mean--if you want to keep that nice little company of yours on track.
Will This Capital Spend Save Me--or Kill Me?
In the surface, business seemed great at Murder Mystery Company, the theater company Scott Cramton founded in 2009. By 2012, the business had sales of $4 million, 30 full-time employees, 800 independent contractors, and troupes in 25 cities putting on roughly 5,000 performances a year. But the fast growth had a downside: Cramton realized he was losing control of the company's finances.
Three years earlier, Cramton quit his job as a furniture salesman to focus on building the company, which he had been running part time out of his basement in Grand Rapids, Michigan. Encouraged by the local success of the business, which put on interactive theater performances, mostly at private parties, he set up websites advertising the business in several cities around the country.
When he got a few bookings in one city, he would fly there to hire and hold rehearsals with local actors. In some cities, he established and trained a part-time satellite troupe to do several weekly shows, including small birthday dinners and large corporate events spanning several days. He hired salespeople, who, in turn, added cities quickly, including Orlando, Chicago, Seattle, Los Angeles, and New York City. In some places, the theater company began putting on weekly performances in restaurants. "It's not a very hard sell," Cramton says. "We find mom-and-pop restaurants with good food. We say, 'You need customers. We'll pay you money. Would you like to do 18 parties of 200 people?' "
As the company grew, Cramton lost his handle on its finances. Incidental expenses--for gas, props, costumes, and copying playbills--were out of control, reaching as high as $8,000 a month in total. "It was impossible for us to keep track of thousands of transactions," he recalls. Managers were traveling around the country putting out fires, which cost the company as much as $10,000 a month for airline tickets, hotels, and rental cars.
Meanwhile, Cramton also suspected that as many as 5 percent of customers were sneaking into shows without paying. And those who did pay were buying their tickets online as many as six months in advance. That might seem like a good thing. But Cramton had a hard time tracking the enormous reserve, which included hundreds of thousands of dollars earmarked to cover future dinners, salaries, and other costs.
The company had no real accounting system, and its part-time accountant was lobbying hard for a chief financial officer or controller. Cramton knew the accounting troubles were getting out of hand, but he was opposed to "paying people too much money to watch our money," he says, adding: "I didn't want to spend $2,000 to save $1,000."
So Cramton considered an alternative: buying 25 tablets, one for each troupe, that would serve as virtual "will call" ticket windows at various performance venues. Using the tablets, employees could check in audience members who had paid online and take payments at the door from those who hadn't. Troupes could also use the tablets to hold Skype videoconferences with managers at company headquarters, which was likely to cut down emergency travel. Meanwhile, Cramton was also weighing the benefits of developing cloud-based accounting software that could be loaded on the tablets and would suit his company's unique needs. But given all the other drains on the company's cash, neither investment seemed like a sure thing.
Any growing company eventually comes face to face with the question Cramton did: Is it time to put capital into building new capacity, and will it pay off if you do? It's a tough one. Gary Kunkle, Inc.'s resident economist and a specialist in long-term growth strategies, says one of the biggest reasons growth companies stumble is that they fail to invest in capacity and can't keep up with demand. Which is sobering enough--until he adds that another major pitfall for growth companies is investing too much capital to meet demand that never materializes. In that case, your capital outlay could create a burden (in leasing fees, debt payments, or depletion of precious cash) great enough to sink the business.
Many entrepreneurs make the mistake of getting stuck on the niceties, wondering if the capital investment will streamline things or add convenience, says John Terry, founder of Dallas advisory firm ChurchillTerry. Instead, Terry says, you should focus on one simple question: Will it bring money in the door? If it won't, he adds, "just put your head down and keep pushing forward."
Cramton calculated that 25 Samsung Galaxy tablets would cost less than $3,000. Not bad. A nationwide data plan for all the devices would run $250 per month--a small fraction of the company's current emergency-travel expenses. As for customizing an accounting system, Murder Mystery Company's in-house IT person estimated he could create one in a couple of months, for about $10,000. Cramton decided the numbers were low enough, and that he had enough cash on reserve, to take the gamble.
A year later, IT is still refining the accounting system (named Watson, after Sherlock Holmes's sidekick), which came in on budget. More important, the software, which is installed on every tablet, is producing results. Since Watson began tracking the troupes' credit card activity, spending has decreased 75 percent, to about $2,000 a month. Cramton attributes the drop to the fact that employees are spending more wisely now that their activity is being tracked.
The savings paid off the cost of the accounting software in less than half a year. Meanwhile, spending on emergency travel has dropped off almost completely. And now that workers are cracking down on people sneaking into performances, the company is saving a couple hundred dollars per performance, estimates Cramton. Best of all, his troupe members began using tablets to sell souvenir photos that are shot by a professional photographer, then printed and framed on-site. The unexpected revenue stream has produced more than $200,000 a year. In 2013, Murder Mystery Company generated roughly $12 million in sales.
Cramton clearly made the right decision when he bought the tablets. By Terry's calculation, eliminating the 5 percent theft rate has boosted profits at each show 40 percent, on average. The most astonishing result was the windfall from selling souvenir photos, he says: "That may be one of the single best capital investments ever made."
Terry thinks Cramton could achieve even greater cost savings by distributing prepaid debit cards, instead of credit cards, to troupe members. He should also consider establishing an incentive plan for each city's manager. For instance, he could give managers 10 percent of any additional revenue stemming from their suggestions. "For every dollar they add, he would get an additional nine," Terry says. "That's a huge return."
I'm Making a Profit. So Why Am I Running Out of Money?
Alan Knitowski treats cash flow like a religion at Phunware, his mobile apps company. But it took two liquidity nightmares at previous companies to show him the way. In the 1990s, Knitowski co-founded his first company, communication software provider VoViDa, with just six months of funding. In those days, Knitowski explains, it took much longer to develop software, and VoViDa was plowing large amounts of cash into paying programmers. "We were burning money constantly, faster than was sustainable, until we became a buffalo charging off a cliff," Knitowski recalls. Fortunately, he and his team raised enough equity funding to stay alive until Cisco Systems acquired the Silicon Valley business, less than two years after it was founded.
Cash-flow problems were even worse at Caneum, the IT outsourcing company where Knitowski was an investor and member of the board of directors from 2003 to 2009. When California failed to pass a state budget one year, one of Caneum's major clients, the Los Angeles Unified School District, was unable to pay its $660,000 bill. Caneum was also struggling to collect a $750,000 payment from another client that was undergoing personnel shuffling. Then, the global credit crisis hit in late 2008, leaving the business without access to cash. The company went bankrupt the following year, and Knitowski took a huge hit on his investment.
When sales and profits are surging, it's easy to assume that your business is bulletproof. But companies can turn a profit right to the brink of bankruptcy. How? The quick answer is that when companies grow, they become more complex. When you have a handful of customers, tracking down payments is easy. As your client base grows, staying on top of accounts receivable becomes more time consuming. New customers may insist on paying in, say, 60 days, even though rent, payroll, and other bills are due in 30.
Meanwhile, more cash is flying out the door to cover inventory, higher taxes, government-compliance expenses, and debt. "As sales go up, cash can go down," says William Lenhart, a business-restructuring consultant with BDO Consulting in New York City. "Every growing business has that problem." But, Lenhart says, many businesses fail to focus on liquidity. That could be because entrepreneurs are focused on selling and satisfying their customers. But if you don't make cash-flow management a priority, Lenhart says, "you could be in big trouble in a short period of time."
Knitowski says the experiences at VoViDa and Caneum taught him a valuable lesson: To survive, business owners have to view cash as their lifeline. When Knitowski co-founded Phunware in 2008, he decided to make cash-flow management a central focus at the company, which develops and hosts mobile apps for clients such as the NFL and Nascar. Every Friday afternoon, Phunware's controller emails an overview of the company's financials to the management team, including data on key metrics such as cash on hand, obligations, and the quick ratio, which the company derives from dividing cash plus receivables by current liabilities. "We don't let one week go by," Knitowski says.
The team dissects the data and tracks trends over time. If cash is trending down, it could be owing to seasonality. Or Phunware may be spending too much--making too many investments in technology, say, or hiring too many people. (The company now has 160 employees and generated roughly $22 million in sales last year.) These days, the company is particularly focused on accounts receivable, which are hovering around $5.5 million. The team asks a lot of questions: Are companies paying us too slowly? Which customers haven't paid us, and how delinquent are they? What action should we take?
Knitowski has also adopted a color-coded system: If Phunware has more than 18 months of cash on hand, it's a green light. Twelve to 18 months of cash is a yellow light, and less than a year of cash is a flashing red light. When the light turns yellow, Phunware turns to a working capital line of credit, asset-backed loans, bridge financing, or equity funding. Thankfully, the light has never turned red.
Phunware also pushes back when negotiating contracts with clients, refusing to accept payments later than 30 days after delivering a product. The company asks some clients to put 50 percent down when signing a contract. And the business is structured so that a portion of revenue comes from semiannual subscriptions, which produce predictable, recurring income.
Phunware isn't shy about hunting down delinquent customers. Nine times out of 10, Knitowski says, those clients wind up paying. He assumes the remaining 10 percent have financial problems they're refusing to disclose. The hard-nosed approach has cost Phunware some customers, but that's a price Knitowski is willing to pay. "I always assume nuclear winter, which makes me conservative and diligent," he says. "That way, things will never be so bad again."
Lenhart applauds Phunware's weekly cash-flow analysis. He also likes the fact that a portion of the company's revenue comes from subscriptions. As the business continues to grow, he says, it will be crucial for Phunware to have the right billing department in place. After all, the department that handled billing when Phunware was a $1 million company may not be up to the task when it's a $30 million company. He also recommends that Phunware adjust its line of credit with the bank at least once a year, to reflect rising sales.
If certain clients are keeping Knitowski up nights, but Phunware wants to keep them around, he could take out credit insurance. He could also ask clients to set up a standby letter of credit that Phunware could draw on if the client fails to pay. The key takeaway for other companies, Lenhart says, is to "look beyond just sales numbers, because they're not the full story."
How Do I Really Know How I'm Doing?
When childhood friends Rob Dube and Joel Pearlman founded Image One in 1991, the closest thing they had to an accountant was Pearlman's father, a corporate CFO who checked their income statements over dinner. They started the business after graduating from college, selling printer and copier toner cartridges and soon adding office machines to their offerings. In the early days, Pearlman's father urged them to spend more time analyzing the Oak Park, Michigan, company's finances. As revenue approached $1 million in the mid-1990s, Pearlman's father found a bookkeeper to serve as Image One's controller. But Dube paid little attention to the company's financials. "I wasn't willing to put the time in," he recalls. "Our mindset was, 'Just get out there and grow the business.' "
Tracking your company's financial data can have a big impact. No, really. Business owners who start to do it usually find it eye-opening, rewarding, and even addictive, says Brendan Anderson, co-founder and managing partner of Evolution Capital Partners, a private equity firm based in Cleveland. And, thanks to the abundance of easy-to-use financial dashboards, gathering and crunching data has never been easier. Yet many business owners resist it, viewing the financial aspect of their companies as something to be tolerated.
Anderson says that only a small fraction of the hundreds of business owners he meets with every year use a formal system to track and analyze company metrics. One reason for the resistance could be that many entrepreneurs who did just fine without data analysis in the early stages of businesses don't see a need for it. But, Anderson says, "there comes a point in time when you can't do it all in your head, when there are more balls in the air than you can juggle."
In 1999, with revenue approaching $2.5 million, Dube began to realize he could no longer ignore the balance sheets. "Eventually, we came to understand that there's a lot more that goes into building a sustainable business than selling," he says. That year, Image One adopted the Entrepreneurial Operating System, or EOS, a process created by author Gino Wickman that involves tracking critical numbers to set priorities and resolve problems. The partners began using EOS and a financial dashboard to monitor weekly metrics related to liquidity, accounts receivable, inventory, and sales. The dashboard also told them if they were on track to meet their budget and revenue goals.
The system had a major effect on Image One's approach to purchasing. Dube began to see that cutting just $1 or $2 from the price of each item could increase the company's overall margins significantly, because it purchases thousands of items from vendors every year. "It was a light-bulb moment," Dube says. "It took us to another level." The $15 million company, which has 60 employees, recently hired a full-time purchaser to negotiate better terms with vendors.
These days, the partners use e-Automate, financial software from Digital Gateway that handles metrics, as well as accounting, billing, and operations. The software allows information from all three areas of the business to flow into a wide variety of reports accessible by the management team. Managers also use the dashboard to track profitability for Image One's 200 largest customers. If margins fall, managers figure out what, if anything, they can do.
Anderson thinks more small businesses should follow Image One's lead. "It's amazing what you can do with a very traditional business when you put in a process and use numbers to drive decisions," he says. Buying software is the easy part, he warns; what's hard is sticking with the process. To make the most of metrics, you also have to be prepared to face up to what you're doing wrong--and resolve to fix it. As Anderson tells his small-business clients, using metrics to run your business is like playing on a college sports team. "You get up every day and figure out if you won or lost, and if you lost, how you could do better," he says. "Without data, you're on the treadmill, battling the same fights you battled 10, 20, or 30 years ago."
To discover what we can do, read about what we’ve already done. For years, we’ve helped businesses access the cash they need to meet payroll and operating expenses, take advantage of new opportunities, and do what they need to stay ahead. At Cash Flow, we retain customers for an average of five years, much longer than the industry average. That’s proof of our outstanding customer service.
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