Calculating How Long Your Cash Will Last (#350)
/How do you determine how long your cash will last? First of all, don’t expect to find this information in your financial statements. It won’t be there. The focus of the financials is on how much money you made, your financial position, and how you’ve already used cash. There’s nothing about a cash forecast in there.
Model Cash Flows
Instead, you’re going to need to build a cash flow model, and it’s going to have to be very detailed, because if you want to know how long your cash is going to last, it’s a pretty good bet that you’re on the edge of bankruptcy. So, be as specific as possible. That means listing your best guess for when every reasonably large receivable is going to be collected. This does not mean that you have to separately list out every single one of them. Just use the 80/20 rule, where you list the 20 percent of customers that constitute 80 percent of your sales. For everything else, lump it into a single cash receipts line item.
Then do the same thing for expenses. Again, use the 80/20 rule, so you’re itemizing the 20 percent of suppliers that constitute 80 percent of your total expenses. Be very specific, and itemize exactly when you plan to pay a supplier for each specific invoice. To make this really comprehensive, include in the model the supplier invoices that you know are coming, but which you haven’t received yet – like the rent invoice, or the electricity bill.
Review Discretionary Expenses
At this point, it’s also a good idea to bring up discretionary expenses. Your goal is to make the cash last as long as possible, so have hard discussions about which expenditures you’re going to stop, such as employee training, and travel, and building maintenance. These need to go away for as long as you’re having cash flow difficulties. Be formal about it, and put out a memo about which expenditures will stop.
This gives you the building blocks for a cash projection. Offset the projected cash inflows against the projected cash outflows, and now you a first pass at when the cash will run out.
Analyze Compensation
But that’s really just a starting point, because if you’re in a fight for survival, you now need to start working through every variable in the projection. Right away, decide whether you can afford to let anyone go, and do it right now. The earlier you do a layoff, the more cash you’ll have available later on. Seeing that compensation is one of the largest expenses of a business, this is a biggie, so don’t wait.
Next, look into pay cuts. This always starts with the management team, because they have to set an example for the rest of the company. If anyone’s going to take a major cut, let it be them. Or, you might offer shares in the business in exchange for salary reductions. That’s an easy one, since if the company might fail anyways, who cares about ownership percentages?
Accelerate Receivables
Then work on accelerating receivables. This means offering a really juicy early payment discount on your billings. And make sure that customers know about it. And on top of that, assign way more staff to collecting overdue invoices. And, once again, the 80/20 rule applies. Focus your collections work on the 20 percent of invoices that make up 80 percent of your accounts receivable. The point here is to be focused on bringing in the cash.
String Out Suppliers
Next up is stringing out supplier payments. If the business is going to go bankrupt anyways, then you can afford to annoy suppliers, and drag out payments. But this needs to be highly targeted. Some suppliers are more important than others, so you may need to pay some of them right on time, while others can be pushed out for weeks or even months.
Update the Model
At this point, you should have a really good idea of how long your cash will last. But keep in mind that the situation will change every single day. So, if you’re really running short of cash, then you’re going to have to set aside time every day to update the model based on cash inflows and outflows, and also what your collections people are telling you about the probabilities of payment for specific invoices.
Set the Time Buckets
Which brings up one final point, which is the size of the time buckets that you’re using in the model. You might be tempted to set up one-day time buckets, but I’d argue that you can’t reasonably expect to predict incoming cash right down to a specific day. So instead, I suggest using a one-week time bucket, and setting up these intervals for as far out in the future as you expect to have any cash. The further time buckets will mostly contain estimates of cash inflows and outflows, and so will be the least accurate. But as those time buckets move closer to the present day, you can swap out the estimates for real incoming and outgoing payments, which increases the accuracy level.