Just like jets consume fuel, scaling up consumes cash In broad strokes, there are three uses of cash. The first is working capital that covers the timing differences between paying your expenses and when you get paid by your customers. The second use is funding to build out your business such as hiring talent, space, and equipment. The third is funding business losses or using cash to get through tough times / down-cycles. This is the danger zone.
This Smart CEO article is focused on Working Capital.
Figure Out How Much Your Need
Most CEOs that we work with don’t like fooling around with a lot of numbers, especially numbers in the financial arena. So buckle up your seat belts because this gets slightly technical.
First, measure the maximum number of days between when your team does the work including shipping product to when the customer bill is sent. Then add the average number of days to when you get paid, this is called Days Sales Outstanding (DSO) to determine the total number of days from when you do the work to when you get paid. This number might surprise you!
This is a subset of the Cash Conversion Cycle (but CEOs don’t like going into rabbit holes).
Next calculate the daily total cost to run your business including overhead, sales & marketing, and direct cost. This number might surprise you as well. Multiply this amount by the total number of days to calculate the minimal amount of working capital that you need.
The last step, since the world is not perfect, is to add a hedge. Figuring out the hedge is more art than science and is influenced by how big or small the minimal amount is. We typically hedge by 10-30% to ensure that we have enough fuel for the full flight.
Get Capital Proactively
Think about how a bank would see your company and its finances.
- Do you have a good story about your loan-worthiness?
- Does the number story make sense or are there anomalies that you can explain easily?
- Can you access a credit line that can cover the time you need to make payroll and pay vendors before you get paid?
Even if you practice strict payment deadlines, it is normal not to have the cash you need to cover working capital requirements. Most often, the cash gap widens as growth accelerates and as the absolute size of the business gets larger.
Banks will look at your number story to determine how much “free” cash you have to support a loan. Many banks want something like 125%. In addition, banks and other lenders will compare your performance ratios to competitive benchmarks to determine if you are a good credit risk or not.
Do you know your free cash flow amount and competitive benchmark standing?
Now that you are ready, be Bold! Establish relationships with local, regional, and national banks plus other lenders such as PE firms before you need the cash. In my book, The Growth CFO Void, that I wrote with Forbes we discuss that being proactive sets you apart. Lenders appreciate periodic updates, they will guide you to get the outcomes that you are looking for plus introduce you to others in your business community.
Start the Conversation Before You Need It
As an entrepreneur, lecturer, and author, I respect my contemporaries who are asking bold questions. The best business owners never stop learning.
Every CEO has unique personal motivations, but their objectives almost always match the following:
- Win new customers
- Retain and grow existing customers
- Attract and develop people capacity
- Reach top financial performance
- Gain access to capital at favorable terms
How Foresight CFO Is Different from Other Outsourced CFO Services?
At Foresight CFO, we focus our mission on providing CEOs like you the clarity and confidence to tackle these objectives effectively. Get the peace of mind you need to handle business and let’s obliterate your obstacles together.
If you would like to learn more, Schedule a 25-minute Discovery Consultation with me