Chapter 6: Cash is King

If there was a book of business poetry it would be full of odes to cash.

Cash is the only life and death issue for your business. There are lots of important things you can worry about -- people, products, service -- but they are important because they impact cash. Businesses with cash live. Businesses without cash die.

Profit is important and it is the reason businesses exist, but it is not more important than cash. If you have the cash you can run an unprofitable company for years. Many companies in fields like bioscience have long research and development cycles and have yet to sell a product. There are a number of dot-com companies still in business today that have never earned a profit. They are all in business because they have cash in the bank.

Enron was one of the most spectacular business failures on record. Arrogance, greed, and corruption are among the many reasons given. The reason for the actual failure, though, was that they ran out of cash. As long as they had cash (and could continue to get more) the doors stayed open and the lights stayed on. Moral and ethical failings may have led to it, but the collapse did not come until the day the cash was gone.

Cash is not a number. Do not confuse it with income or expenses. Your receivables might slow down or even disappear if a customer is experiencing their own cash crisis. You may be able to get extended terms or use a rolling reserve against returns to defer cash payments on payables. Cash is a precious substance, not a piece of data.

Cash is about survival

Cash equals survival -- for your business and for you. Unless you are running a restaurant, cash is the only thing in your business that you can eat.

(If you are running a restaurant, it can still be bad. When my wife was young her family ran a restaurant that failed. They ate frozen crab legs for weeks afterwards -- and today my wife is allergic to crab.)

There is no way to predict the extraordinary expenses that come up in business -- having cash on hand is the best way to prevent these bumps from derailing your train.

My business licenses electronic rights to books and databases. In the process of acquiring rights to a new title we discovered that we had accidentally left a previously licensed title from the same publisher off of our royalty calculation spreadsheets for more than five years. The accrued royalties were significant. Having cash on hand, though, allowed us to survive the crisis. We were able to make a single payment to catch up and to preserve the relationship. We also avoided a license revocation that could have forced us to reconfigure our products, destroy inventory, and incur even more expenses.

Cash is about opportunity

The real power of cash is that it creates opportunities. When you have cash you can move more quickly than your competition. You can exploit opportunities before anyone else and you can create new opportunities by putting your cash to work.

I once had a smaller competitor that was a profitable division of a public company that was in big trouble. The public company needed to focus on its core business and was willing to sell my competitor to me. It was the perfect acquisition: I would acquire a profitable product line and a solid base of repeat customers that could be easily moved to my platform while reducing the overall overhead. The price was great too, because the public company was desperate for cash.

I did not have the cash, though, or the time to arrange financing. The seller was in a hurry and gave the division to a large creditor in exchange for release from the debt. Today I keep enough cash on hand to do that deal, or one like it, if it comes up again.

Cash gets great discounts. Your accountant can help determine if you should take a 2% cash discount from a vendor or pay Net 30. That's peanuts, though. You should be looking for opportunities to save 30-50% (or more!) by slapping cash on the barrelhead.

Looking for big discounts is not about exploiting others' weaknesses. It is about understanding that cash can be worth more than its monetary value and that everybody has a different cost to acquire it. Your early discounted cash payment could be the difference between meeting payroll or not for a vendor. A great discount for you could be cheaper than the outrageous rate at which a vendor has financed its receivables while still more than you could earn on the cash yourself.

My last house was new construction covered with a guaranteed siding material. It was discovered that a manufacturing defect caused this siding to rot away in just a few years. The manufacturer was buried with warranty claims and soon homeowners were buried, too, with piles of time-consuming paperwork related to a class action lawsuit.

My claim under the class action was approved and a payment specified. The only problem was that the payment would not be made for years -- and only then if the company chose to re-fund the already tapped-out claims fund.

A planned move of my business to a new city meant that I had to replace the siding immediately in order to sell the house. All my cash was going into these repairs and the purchase of the new home, and all my borrowing power was going into the new mortgage.

When a letter arrived with a check offering a heavily discounted early payment in exchange for release from the claim I cashed it immediately. It was a welcome relief from the hassles and uncertainty of the ongoing claim and provided cash at a time when I could really use it. Financially it was a terrible deal, but it removed the risk and provided cash I had no other way to acquire.

I learned later that this discounted payment plan allowed the company to settle $91 million in claims for $32 million in cash. That is the power of cash!

Managing your cash

The way cash flows and how much you need to have on hand is different for every business. The need to manage it well -- to respect and even love it -- is universal.

Your bank can help you manage your cash with tools like lockboxes and sweep accounts. They will know which tools are the best fit for your business.

Securing a line-of-credit when you do not need one, for the day when you do, is another way you can build a cash safety net.

The most important part of cash management, though, is in your hands. You need to create a cash-aware company culture and, unless you are more disciplined than any entrepreneur I have met, put systems in place to protect you from yourself.

When cash is tight you need systems to ration it while doing as little damage as possible to your business and reputation. Among the things you can do to ration cash:

  • Slow down your payables. Call your vendors and be honest with them. Tell them things are tight and when they're going to get better. Apologize and ask for longer terms. Make partial payments even if they are not required. It shows good faith and puts off worries that you won't meet your obligations.
  • Create an expense review committee. People hate committees. They're big and slow and terrible at making decisions. That is why you should create a committee to review and pre-approve every expense over $100. Put your most tight-fisted staff on it and do not sign any check the committee has not approved. (Make sure the committee meets as infrequently as possible.)
  • Don't pay the rent. Unless you are in a very hot market for commercial real estate, there is no one more interested in your continued success than your landlord. It is difficult, expensive, and time consuming to evict a tenant, and there may be a lot of vacant months before a new tenant starts paying rent. The landlord knows this. When things are tight, call the landlord and be completely honest.

When cash is plentiful good decisions are more difficult. You need to find balance between hoarding it for safety and employing it to grow and seize opportunities.

In my business we maintain four levels of cash.

  • The top level is the working cash. This is the money we use on a daily basis to run the company, and the balance of this account is watched carefully every day. We are careful with this cash, but not afraid to use it.
  • The next level is the working cash reserves. Every day we set aside a percentage of that day's sales to cover large, regular expenses. By reserving the cash for payroll, taxes, and other fixed-percentage costs ahead of time we ensure that we'll never miss a payment on the most important payables. (This also prevents us from having misleadingly large amounts of working cash right before large quarterly payments are due. If we did not set aside the cash for these upcoming payments our management team could be making decisions based on bad data -- spending money that we would need the next week.)
  • Level three is the rainy-day reserves. This is where we accumulate cash for surprise threats and opportunities -- an acquisition, capital expenses, dispute settlements, etc. We do not touch this cash without approval from me and several senior managers. If possible we do not touch it at all -- we try to cover these expenses from the working cash.
  • The bottom level of our cash reserves is the squirrel fund -- acorns saved for winter. We set it up when we came out of a period of heavy debt and had a product that was a surprise best seller. We took a portion of the excess cash it generated and took it to a new bank where we put it in an account with only one signer. The banker was surprised when we declined the checkbook for the account. To use those funds I have to go to the bank in person and fill out a bunch of paperwork. I wish it was less convenient than that.

A friend has a specialty construction business that involves large customer deposits against costs that can stretch out over two years. She has identified the danger of spending those deposits on operational expenses and getting caught without the funds to cover the materials expenses that follow a year or more later. To avoid a crisis she has set up a cash management procedure that keeps deposits apart from operating cash, trickling out funds in careful relation to project costs.

Your business has unique needs. Find the most paranoid-conservative cash management system you can that meets them.

Every morning you should know how much cash your business has on hand. You should know how much you will have for the next week, have a good idea how much you will have for the next month, and have a plan for how much you will have for the next year.

Cash is safety, cash is opportunity, cash is power. Cash is king.