Survival = Positive Cash Flow

Happy Day! 🥳

“Everything that can be invented has been invented.” — Attributed to Charles H. Duell, Commissioner, U.S. Office of Patents, 1899.

A 2016 study by U.S. Bank drilled down into the main reasons why small businesses fail . They found that 82% of the time poor cash-flow management was the issue.

Most entrepreneurs I meet confuse cash with cash-flow. They are different things. In the early stage company entrepreneurs invest cash in the business. These expenses may be for things like inventory or marketing services in anticipation of demand. Forecasting demand accurately is often little more than a guessing game. Then a time period passes before actual sales take place, and then a further time period before revenue comes in after the product has been received or the service provided. It is the time period between when cash flows out and when cash flows in that causes the issue. Cash flowing out to vendors and manufacturers can be fairly immediate and they are not obliged to be patient over payment. Cash flowing in from sales, however, can take a long time to show up and often comes in unpredictable waves.

My favorite cash-flow anecdote to demonstrate the issue concerns an entrepreneur called Adam Osborne. After selling his successful computer-book publishing company to McGraw Hill, Osborne started a pioneering personal computer company called the Osborne Computer Corporation. He used $100,000 of his profits and a loan from a venture capitalist of $40,000.

Founded in 1981, the company sold the first inexpensive (by 1981 standards) portable computer. The Osborne 1 weighed 24 pounds and was the size of a sewing machine. In fact it looked a bit like one. It had a carrying handle and would fit under an airplane seat. It did not have a battery, so could not be used in-flight, but executives could finally have a way to take their office files with them.

Dealers were enthusiastic, and the first units shipped in June 1981. In August 1982, the company sold $10 million worth of computers. By February 1983, its sales on the books reached $100 million. By all measures, the company had the fastest growth in computer sales history.

In 1983, however, Osborne announced to his customers several next-generation computer models, which had not yet been built, highlighting the fact that they would outperform the existing model. Sales of the Osborne 1 fell as sharply as they had risen as customers anticipated those more advanced systems and cancelled their current orders.

Facing being stuck with a mountain of suddenly unwanted and obsolete inventory, Osborne reacted by drastically cutting prices on the Osborne 1. Customers, however, did not want to buy an inferior model no matter how discounted.

The first high-profile evidence of trouble at Osborne Computer came in June 1983, when InfoWorld published a story that said the company was suffering from a cash-flow issue, and that delays with the new machine had hurt Osborne 1 sales. By then, layoffs had begun. In July, the Journal published another story on Osborne’s plans to go public, saying that financial woes had forced the company to give up on them:

Sales of its Osborne 1, a best seller in 1982, fell off sharply in the spring, when the offering was to have been made, forcing the company into a cash squeeze. Osborne Computer’s main problem has been the timing of its introduction of a new portable computer this spring. Dealers cut off orders for the Osborne 1 to wait for the new machine, but it was behind schedule.

“We had an April with no income,” says Adam Osborne, the chairman. The company was also coming out of fiscal 1982 with flat results or a loss, and competition from newcomers in the portable-computer business was intensifying. Osborne takes the blame for the introduction snafu.

This market event, a pre-announcement of a new product causing a drop in demand for older ones, is now known as “The Osborne Effect,” but the real reason for Osborne Computer’s bankruptcy in September 1983 was again poor cash-flow management. Looking back, Thom Hogan, an executive at Osborne Computer attributes their failure to:

“Cash-flow, basically… and decisions relating to it. The company was undercapitalized from the beginning, so the very rapid growth essentially had us ordering more supplies every month faster than we were taking in money on the income side. The company would have sold even more than we did with more capital. Basically it was “buy as much new parts and add as much staff as we can afford” every day. I can’t remember a month where the cash-flow numbers looked great, despite the profitability numbers looking decent.”

Depressing stuff perhaps, but with our mirror neurons fully functional we can observe, learn, and avoid similar errors. It is essential to understand that while cash is king, cash-flow is the issue… for everyone large and small. Many people underestimate the cash cushion they need to get through the rollercoaster ride of the first couple of years when sales and revenue can lag significantly behind cash investment and cash expenses. It is an error that is easily corrected if you ensure you hve access to extra capital from the start. For many small businesses a simple line of credit could have saved them.

It is because of these stories and thousands of others like them that I have approached all my companies with the same set of beliefs:

- Projects cost twice as much as budgeted

- Projects are twice as complicated as anticipated

- Projects take twice as long as expected before profit arrive

That ultimately leads me to conclude that whatever capital I have, it is not going to be enough to get me safely through. Whatever number I have justified with good mental math I double.

When it seems a simple concept to grasp I have often wondered where so many new entrepreneurs learn such bad habits of cash-flow management. We don’t have to look much farther than our typical workplace where most have had a regular career.

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