Cash flow or profit? What attracts investors to your business?
(This article was first published in medium. The link to medium article is here:
Growing businesses need to focus on getting one thing right. Which is to get their financials done well with a clear plan for the long haul. When dealing with many small businesses, we have seen that they focus on achieving profits very early on, even while ignoring another critical aspect of finance, which is to sustain the everyday operations of a company with a healthy cash flow.
One of the fundamental aspects of a business that investors look for, before they invest in a business is the cash flow statement. Because, for a company with scale as the priority, profit is long term and cash flow is immediate.
Cash is Oxygen. We have seen many companies GROW into being completely BROKE without cash while making profits! That’s insane, right?
Let me explain the two with simple examples:
You are in the business of selling furniture. You make an excellent monthly profit of $15000 in profits after all the expenses, deductions, and taxes. This is great! However, for you to operate your business for the next day, you need, say, $20,000 in cash on an everyday basis. This includes paying salaries, paying operational expenses, transportation, credits, etc.
The $15,000 profits you made are nothing compared to the everyday cash flow needs your business has. This cash needs to come from liquid assets, like cash from customers, stocks, cash reserves, mutual funds, bonds, money market segments.
If your business runs out of operational cash on a day-to-day basis, there is no way you can operate the business. To manage the cash shortage, you will raise more capital, borrowing from lenders such as banks. Or the investors need to pump in more cash to help your business thrive. If your business hits this scenario, too often, then, it is on the verge of a severe downfall.
Because if investors refuse to invest more, then the business will be forced to sell its solid assets at one point (which is bankruptcy).
Understand this: There is zero leverage for a business owner that has negative cash flows. Banks will charge higher interest rates, Investors will ask for selling solid assets to take their money back. Cash is spent only on two things: Making the product/service. Fixing management stupidities. You do not want to be caught on the latter.
Investors are generally looking for ROI(Return on investment) and a sound business model to give the ROI. A business that does not show promise of at least the start of an ROI in 3–5 years, with a decent percentage on par with that industry, is not a good investment option for investors. A poor cash flow is an alarm signal to investors because it implies that investors need to invest more money to keep the business alive.
Hence, our advice to businesses in the growth stage is to focus on cash flows and increase the liquid assets that can result in positive cash flow.
And who can generate that cash? Customers. This is also why Amazon, Uber, and many innovative businesses focus on customer acquisition in beast mode, turning the company into a cash machine. Without showing a positive net margin or profits to date.
Now, is profit not important? Of course. All businesses exist to make profits. It is a question of what the owners want.
If a company’s focus is to make profits, then faster scale and growth may not be possible. In such a case, the company is more focussed on a niche segment, high price point, tighter operations, and has built enough cash reserves rather than cash flow. Not every business can do this or digest this risk.
Profit is usually perception and can be presented positively. Nothing is a fact in your financial statements except Cash flow and cash reserves. Hence if you are in a business that is trying to attract non-emotional money (money coming outside of your savings, relatives, friends), then focus on aggressive customer expansion and cash creation.
To take an example: Costco’s cash flow comes from the membership card, which creates a tremendous amount of inflow into the company while allowing it to sell wholesale at an aggressive price point.
Successful startups spend significant investor money on customer acquisition activities. Not on making a fool-proof product. Not on quality. Not on customer service. They let such fires burn. Let the product be a minimal viable product. Focus on customer acquisition and repeat business and referrals from the customers.
This is the only way to increase liquid assets before going into an IPO and to attract cash into the business.
Once investors see that you have a growing customer base and that your business attracts money, you will attract more money. More investors. Higher risks. All this even without profits.
Finally, outside of customer acquisition, how can you increase cash flow? By tweaking and playing around with the seven well-known financial levers. In the very famous book, Mastering The Rockefeller habits 2.0: Scaling up, Author Verne Harnish refers to the Power of One. Which is adjusting each of the seven levers by 1% to see an improvement in cash flow drastically:
Price: The price of your product
Can you increase the price of the product to increase cash flow? Or can a premium variant be introduced to increase the price? This can immediately result in better cash flow.
Volume: The number of units you sell
Can the volume of sale be increased? Any new sales channels? Any expansion opportunities within existing customers? Can the product that makes the most profits, be sold more?
Cost of Goods: Cost of raw material
Can the raw material to produce goods be sourced from alternate source and thereby, the price be reduced? How can the cost of goods be reduced by 1%
Opex: Operational expenses
Salaries, electricity bills, transportation, logistics, coffee, tea, food, travels. Can you take a decision to cut all of this by 1% so that there is an increase in cash flow?
Accounts receivable: Money from debtors
Can you ask debtors to pay in advance? Reduce 60 days to 30 days?Or can you increase the lending percentage for your debtors so it attracts more revenue?
Inventory: The unsold stock you keep
Can you produce less or buy less so there is less inventory? Can you focus on aggressive reduction of product shelf life and rotation across franchises so that there is minimum stocks at any point?
Accounts payable: Payment to credit lines
Can you delay your payments to credit lines? Can you buy more time?
These are all some interesting ways to manage cash and show a positive business trend to investors.
A good referral is also here.