Knowing how long your business can run in the red is crucial when it comes to making decisions about when to take risks and when to lay low. Also called “operating cash flow margin” or “margin ratio”, your cash flow margin measures how well your daily operations transform sales into cash. Relating cash flow from operations to net sales provides a powerful insight into the inner workings of a small business. If you’re generating a negative cash flow, you’re losing money even as you generate sales, which is unsustainable. A negative cash flow leads a small business to begin exhausting cash reserves or taking on more debt just to keep the doors open.
Calculating your ‘cash runway’ is the process of defining the fine line between keeping up appearances and bouncing checks. However, calculating your business’s runway is more nuanced than most small business owners realize. You must have an intimate knowledge of not only your personal cash runway, but also of how the dynamics of employee and founder cash runways can affect that calculation as well. Understanding all three of these components and how they are intertwined is key to navigating the inevitable financial ups and downs of running a small business.
The most common reason for businesses to exceed their cash runway is flat-out poor cash management. It’s easy to get caught up in the euphoria of initial or seemingly-steady success and feel bolder about moving forward with costlier investments. Don’t take your eye off the ball. Experts recommend that you calculate your cash runway at twice what you need, especially if you are turning comfortable profits for the first time.
A crucial and often overlooked component is the cash runway of your employees. It’s common for small business owners to believe that their employees carry the same passion for the company as they do, meaning that they are just as willing to weather the storm as you are. More often than not, employees will cut and run at the first sign of trouble. How the challenges your business faces affects their own personal finances could mean bigger problems in the form of employee attrition, which ultimately affects your cash runway by depleting your resources to get the job done. The loss of employees means the loss of customers, sometimes rendering your careful math null and void. If you find yourself approaching this point, consider options such as other non-cash compensation to counteract turbulence and keep employees invested in the company's long-term success.
Concerns over the final factor – founder cash - tend to become front and center after employees have already started leaving, once their paychecks have started bouncing. This runway belongs to the people who bought into your dream, who initially invested the cash to get your small business off the ground, whether it was a bank, a private investor, or even trickier – family. At this point, the goal is to convince them to either keep investing, or freeze their return on investment until you can get back to a profitable place. Understanding their cash runway in advance gives you the ability to factor in their financial expectations and keep them supportive and engaged during lean times.
Cash is what a company needs to generate to pay its expenses and purchase assets, and how well a company can convert sales into cash is crucial. Knowing that a company is continually improving its cash flow margin is a key indicator of performance. Treat your small business’s cash flow margin as a real barrier, not something than be extended. That's a recipe for disaster, both personally and professionally
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