Cash is King (or Queen). However, it’s one thing to have cash in your bank, but it’s another to know how to manage it, what to do with it, and how long it’s going to last you. In the previous blog, What is Cash Flow? Revenue vs. Profit vs. Cash Flow, we discussed cash flow fundamentals. Now we will take that understanding one step further.
It's All About The Cash
Keeping a healthy cash balance to run your business is like having enough fuel in your engine to get you to each destination. Cash is the fuel that runs the engine of your business.
A healthy cash balance allows you to:Reinvest in your company
- Invest in new roles to grow your company and your top-line revenue
- Buy new equipment or replace existing dated equipment
- Invest in more inventory to sell to larger customers
- This is the most important element as you’re responsible for peoples livelihoods
- Debt can significantly hamper the growth and success of a company, especially if interest rates are high. Having cash available to repay debt means that your company is less reliant on financing to succeed.
You’ve probably heard the term cash runway and have assumed it is interchangeable with cash balance. Although they’re similar and intertwined, let us walk you through how they differ:
Cash Runway is the length of time you have before you either turn cash flow positive or run out of money, and you have no more gas in the tank to run your business.
So while cash balance is how much money you have in the bank, (i.e., $500K), cash runway is the amount of time that number will last you (i.e., 18 months).
When figuring out your runway, you need to consider multiple scenarios that include expenses, sales, and your hiring plan.
Cliffhangers are underutilized in the startup and business world, but it’s a term worth knowing. Cash cliffhangers typically deal with two different points of your business: cash going out and cash coming in. For context, let’s go over what this means:
- Cash going out
- Simply put, Accounts Payables are the bills or amount of cash you owe someone else for products or services
- It’s money you have committed to pay your vendors or your debtors and will pay in the future, depending on the terms you negotiate
- Cash coming in
- Accounts Receivables is money that is owed to you or that you’ll receive from customers in the future
- These are usually owed to you within 30 days (NET 30) or could go as long as NET 45 or NET 60
When looking at the AR/AP timeline, you have:
1) Date of invoice: when the invoice was issued
2) Payment due date: when payment is expected
3) Payment received: when payment is received
Payment terms are the time between 1) Date of invoice and 2) Payment due date.
The lag between 2) Payment due date and 3) Payment received is the Cliffhanger.
REMINDER: just because “the checks in the mail” doesn't mean you're going to get it on time (or ever).
Cash at risk is the money that is owed to you but not in your possession (not materialized). The longer that money is overdue, the higher the risk that you won’t collect it.
The Importance of a Cliffhanger
Typically, if you're dealing with cash coming and going directly into your account (what we like to call “cash efficient business models”), you don’t generally have payment terms or cliffhangers. However, some models like inventory-based businesses need to consider the realities and impacts of cliffhangers.
- Paying your bills immediately without payment terms limits your abilities to grow as a company. Using Accounts Payable and Receivables concepts is necessary to bring on new customers, expand your business and ultimately play the cashflow game with the most tools available for your success.
- Keeping a moderate level of accounts payable is healthy. Your Company negotiates net terms with its suppliers very carefully to make sure that money isn’t bleeding out of the company too fast or in large amounts irregularly
- Keeping a moderate level of Accounts Receivable is healthy. Your Company negotiates terms with its customers to make sure that it has a steady stream of cash coming in and that cash is readily available to be disbursed for other business needs
If someone else has your receivable in their bank account, it’s not in yours.
- Cash is the lifeblood of your company
- Golden Rule: Make sure that your money is coming in faster than it is going out
- Money that is owed to you but not in your possession is considered “at-risk”
Congratulations, you are one step closer to becoming a financial whiz.