Table of Contents
Recommendation
A start-up is always a risky endeavor, and so Andreessen Horowitz professionals Seema Amble, Melissa Wasser and Emily Westerhold offer entrepreneurs a useful primer on a new business’s most basic need: solid cash management. Cash is the lifeblood of a new business, and knowing its sources and uses is what distinguishes the successful start-up from the rest. Entrepreneurs will find this concise report a useful aid for developing a consistent process that accounts for a firm’s cash needs in both the short and long terms.
Take-Aways
- Proper cash management begins with an understanding of what cash is and is not.
- The deployment of cash should follow a needs forecast and budget.
- Start-up founders need to understand their options in the event of a cash shortage.
Summary
Proper cash management begins with an understanding of what cash is and is not.
Understanding the nature of cash is critical to financing a new business. Cash that is in the bank and readily available is the most liquid. Other forms of cash – like accounts receivable, electronic payments yet to clear, or earned revenue not yet billed or collected – often carry some restriction. From an accounting perspective, cash is recognized on either a cash or accrual basis. Whereas the latter recognizes income and expenses when earned, cash basis accounting identifies inflows and outflows when they actually occur. Cash comes in and goes out due to operating activities, such as customer revenue, salaries and marketing expenses, as well as financing activities that arise from debt or equity funding rounds.
“Cash is like oxygen for start-ups; founders sometimes take it for granted, but it keeps your business alive. Even if you have a great product, growing revenue, and a steady talent pipeline, if you run out of cash, your company is dead.”
Timing is critical in cash management, because mismatches between inflows and outflows can result in a funding crunch. Cash yet to be received is not really cash you can count on. Some assets may be illiquid, such as outstanding loans that the business has granted, money in escrow or minimum sums provisioned to avoid violations of loan covenants.
The deployment of cash should follow a needs forecast and budget.
Once an enterprise identifies what part of its assets are liquid, it needs to manage its runway – that is, how many months of available cash will keep the business aloft. “Operating cash” is what is available to manage the business for the next year; “strategic cash,” on the other hand, is set aside for long-term use and should be less subject to near-term restrictions. Such liquidity may be invested in short-term paper or in staggered bond maturities to generate income, once the start-up’s board of directors approve an investment policy. The business’s budget will identify what portion of cash will be provisioned for the near term versus the long term. Management should review spending needs and cash-burn estimates monthly.
“Your forecast will give you a sense of your expenses, which can be shorthand for cash consumption, but you should also have a view of upcoming payments, some of which may be for expenses incurred in a prior period.”
Uses of cash will vary. Financing cash flow – that is, the cash raised from debt or equity issuance – differs from the cash generated from business operations. Debt proceeds are best suited for specific activities such as talent acquisition, office space rental, sales and marketing costs, acquisitions, and protecting the balance sheet. Equity is more suited to less predictable undertakings, such as new and untested products and services.
Start-up founders need to understand their options in the event of a cash shortage.
Entrepreneurs can find themselves in a tight spot, cash-wise, and how they extricate themselves depends on whether the problem arises in the short or long term. In the latter scenario, in which management foresees a dearth of cash in a few months, it may consider an equity raise, a sale of the firm or some part of it, a cessation of operations, or an exploration of ways to reduce cash burn.
“With a strong command of the timing of cash needs and active runway management, a company can save itself a lot of time and heartache around a painful cash crunch or — worse — death.”
A sudden cash pinch is a different story: Ending credit provision to customers or terminating a product are feasible options but can slow growth in the short run. Short-term demand loans are a possibility, but they carry a cost in the form of high interest rates. Offering current shareholders a convertible note feature to secure bridge financing is a possibility, though with the risk of delays if capital markets are unfavorable.
About the Authors
Seema Amble, Melissa Wasser and Emily Westerhold are partners at Andreessen Horowitz.