Managing Aggressive Growth … responsibly

Growth eats cash. There are lots of stories about profitable businesses that went under due to lack of cash.

As one of my business coaches says, "You can't spend profits, you can only spend cash." What he means by this is that when using accrual-based accounting, you typically recognize revenue before you receive the payment. At Blue Fish, we recognize revenue when we invoice our clients, but they pay us 30-90 days later. So while your books may show a profit, you may not have the cash to pay your bills on any given day. And if you can't pay your bills, you go under. The reverse is also true, by the way - we lost a lot of money last year but were able to weather the storm because we had a lot of cash in the bank.

While any company can have this issue, Growth exacerbates the problem. Here's why:

Assume you run a web-based business where users pay you by the month. You're growing fast, and your current servers can't handle the traffic. You need to buy a new server today, and you decide to buy a big one that can handle 10,000 new users. The server will pay for itself once you reach 5,000 new users. If you don't buy the new server, you won't grow your business because performance on your current server is holding you back. So you need to buy this server in order to grow.

The problem is that you don't have 10,000 new users yet, you only have a couple of hundred, and they aren't enough to pay for the server. But without the new server, you'll never grow to 10,000. It's the classic chicken-and-egg problem. So in order to grow, you have to spend cash. That cash can come from one of 3 places:

1. Investors
2. Cash generated from operating profits
3. Loans

The art of "cash management" is using these three sources to the best result.

My business has been profitable since inception, and I used to buy everything with the cash my operations generated. At some point, I learned that this is BAD cash management, because I was using a very liquid asset (cash) to buy an illiquid asset (a server that I'll use over 5 years). This never got me in trouble, because I wasn't growing very quickly. But about 5 years ago, we started really growing (we were the 10th fastest growing company in Austin). There were

• a lot more servers to buy (that wouldn't be fully utilized right away)
• bigger office space to lease (that wouldn't be filled right away)
• more developers to hire (who wouldn't release products right away)
• and more sales people to hire (who wouldn't fill their pipeline right away).

If I pay cash for each of these things, I'll run out of cash because my business can't generate it fast enough.

So the short course on cash management is to use the appropriate kind of liability to acquire your assets. I learned that it's OK to get a loan to buy something, even when you have enough cash to buy it outright. Even though you are paying interest, it leaves your cash in the bank where you might need it later. So now, I buy equipment through a leasing company that spreads out my payments over 5 years. And I have a line of credit at the bank that I can draw on if I need to cover a short term cash-flow hiccup.

And I keep at least 3 months expenses (not just payroll) in the bank at all times, which means I need to anticipate my expenses over the coming months, and I need to be mindful when I make decisions about when and how much to pay myself.

Here's a similar question about cash reserve guidelines: http://answers.onstartups.com/questions/2388/cash-reserves-guidelines/2406

My un-scientific, personal taste style of answer: At most a little bit less than monthly payroll (so you could always meet payroll with a small overdraft from your account).

Small month-to-month loans are what banks exist for. I know all banks are running scared right now. But your work is about achieving growth, banks are about giving loans to healthy businesses. And in a squeeze your investors are your backup plan, they should be willing to give you a small bridge loan.

You didn't quite say, but I assumes that as a SaaS style company, your monthly income comes from a multitude of small subscriptions. As such your income should be pretty stable and predicable, and that's what I'm basing my answer on.

What you must not skimp on is proper financial oversight within your company, good tidy accounting, and data-driven analysis/modeling of your sales funnel and future cashflow. These help you stay out of trouble, and if trouble finds you anyhow, help convince your bank/investors that you're worthy of their hard earned cash.

Just to be clear: I do not advocate that you play hard'n'fast with payroll or your company's existence. It's just that money in the bank is a lesser effective form of prevention; it is better not to need cash for surprise expenses/lack of income in the first place. So a way to re-phrase your question could be "what would you say the statistical margin of error on your cashflow projection is?".

First off, congratulations on breaking even quicker than plan. That is a great achievement.

Call me conservative, but I like to see cash growing in the bank. So for me, I would grow as long as I was profitable. As for runway, I would strive to have enough to do what you did again. If it took you 6 months to build your first product and $500k, then I would have that on hand.

The other way to do this is to look at your monthly burn rate, sales conversion rate and revenue. See how long it takes to convert sales from initial contact to revenue. Then, adjust this rate down to something conservative or easy to complete. Then, do the math as to how long it will take to make your monthly expenses. Add a little buffer and that should be your reserve.

Just because you are growing does not mean you should play loose with the cash (which I don't think you want to do). When an opportunity presents itself, look at it like you looked at your first product. Be diligent in the business case and fund it like a startup. That way, you know how much you are willing to spend/lose on the new idea.

Jesper makes an excellent point about banks. If you can, go get a line of credit setup. They come in handy in a pinch.

I would keep enough money in the bank so you can always make the monthly payroll. Out of all the expenses and cash outflows a business has I feel that meeting payroll and NEVER missing it is extremely important. It demonstrates your respect for your staff and shows how much you value them.