April 8, 2003

Cash is king: Here's how to keep the king from clobbering you

by Bruce Hadley, SoftwareCEO

Every software company frets about cash. Well, maybe not Microsoft, which had $43.4 billion in liquid assets at the end of 2002. But those of us in the real world need to keep one eye on the checking account balance at all times. And, more specifically, it's the day-to-day flow of cash that matters most — profit is nice, but profit doesn't make payroll.

So, how can you predict your cash flow a month or quarter or year out?

"The problem is that cash flow is not the same thing as profit, so you can't monitor it just by looking at the monthly income statement and balance sheet," says Rusty Luhring, CEO of SurvivalWare. "It can vary quite a bit from week to week, and the consequence of being careless is huge. You can spook your employees by being late with payroll, or incur loan shark-like penalties for letting the federal tax withholdings slide. Of course, the direst consequence is that you run out of cash and have to close the doors."

Luhring thinks all software companies should do some cash flow forecasting periodically, as part of a healthy management practice, and also at special times such as when you're hiring new people or reeling from declining sales. "I suggest getting a cash flow checkup every six months — just like going to the dentist," he says. "Sometimes you'll get a clean bill of health. And sometimes you'll go back for a root canal."

Luhring's something of an expert on cash flow management, because his company has been to the bleeding edge: In the early 1980s he was involved in a lawsuit with a publisher over rights to his software, and that effort put a huge drag on revenues.

"In the year or two after the lawsuit, my company lost between $600,000 and $700,000," Luhring says. "We were, for all intents an purposes, bankrupt, except that we still had customers who were buying, and creditors who were still willing to extend credit.

"I went through periods — mostly in the mid-'80s early '90s — where I wasn't able to pay payroll taxes on time, and I had the IRS requesting their money. I had receivables, I had money coming in, but that doesn't count if you don't have the check in hand when the taxes are due. There were 10 to 12 times in a 10-year time span where the company was running on fumes."

Small wonder, then, that Luhring's business card lists his title as Survivor in Chief as well as CEO.

To survive and manage through these tough times, Luhring created cash management software for his own use. "The software allowed me to work out a plan, which helped us work out with creditors how we'd pay them off," he says.

"Plus, I found that once we had a cash management plan, once I understood where and when the cash was coming from, I could then set the plan aside and focus on servicing the customers and developing the software. I didn't have to worry every minute about the cash flow."

Cash flow forecasting options
Luhring distinguishes between short-term and long-term cash flow forecasting; they are done differently and are used for different things, he says. "Short-term cash flow forecasting is very detailed oriented, and is designed to make sure you have enough cash to meet all of your cash obligations when they are due. You would probably use weeks instead of months as your time periods, and maybe look forward a total of 13 to 26 weeks.

"Long-term cash flow forecasting, on the other hand, is done in connection with a financial model that integrates an income statement and balance sheet projection along with the cash flow projection. The purpose is to look at your overall business model and capital structure, and get a feel for your long-term profitability and capital needs. Long-term forecasting is done at a more summarized level, and the time periods are typically months, quarters, or years. You might go out anywhere from 12 months to five years."

Company size is irrelevant, Luhring says; every software company needs a periodic cash flow health check. "I'm working with a startup now, and they're using it for business s planning before they even get started," Luhring says. "Even if you don't feel like there are problems, they might be lurking. You may have money in the bank, but it could be that you've been lucky, or collections have been faster than usual.

"When you're having problems, you should do the cash forecast more frequently. I've gone through phases where I've done it every two weeks; six months is more reasonable if you feel like you're healthy."

Luhring says there are essentially three small-company alternatives for doing short-term and long-term cash flow forecasting: Excel, QuickBooks, and his own product, SurvivalWare.

Sure, he'd like to sell his software, but that isn't the point of this article, nor is it the reason why Luhring agreed to speak with us. In fact, he was remarkably open about the viability of no-cost alternatives, and even offers a shareware version of his product — more on that later.

Option #1: Use Excel.
Excel represents the most strenuous do-it-yourself approach, but it can work in a rudimentary fashion, Luhring says: "You enter a beginning cash balance. Make the columns weeks, and the rows different cash expense categories. Payroll typically consumes 50% to 70% of a company's cash outflow, so if you get this part right, you are most of the way there.

"Cash receipts are more difficult, because they can vary so much. Just make your best guess week by week. Add a separate line for special one-time events such as proceeds from a loan or a tax refund. Your ending cash is then beginning cash less payments plus receipts; thus, next week's beginning cash is this week's ending cash."

The big advantage of using Excel is its flexibility, Luhring says. You can use as much or as little detail as you want. And, Excel is appropriate for doing the longer-term projection models, not just the short-term cash forecasts.

The disadvantage is that you start with a blank screen — you don't get any guidance about how to do your forecast. "Also, if you want to do a refined forecast of cash coming in based on open invoices and new sales, the formulas get complicated real fast," Luhring says. "Even if you're smart, Excel won't give you simulations — that precision of predictions is missing."

Option #2: Use QuickBooks.
"Using an accounting package such as QuickBooks has certain advantages because, for many small firms, the financial data already resides there," Luhring says. "The disadvantage is that accounting packages are designed to track and summarize transactions that have occurred in the past, not ones that may occur in the future."

However, Luhring acknowledges that QuickBooks has a nifty feature in the Reports module under Company & Financial reports — it's the last report in the list, called Cash Flow Forecast.

"If you are good about entering vendor invoices into the payables module as they are received — as opposed to when you cut the check — it can give you a quick, no-effort forecast for the next two to four weeks," Luhring says. You can actually set the time periods out as far as you want; they just won't contain any numbers."

"The disadvantage of using the QuickBooks feature is that you can't project future sales. Also, most people I've talked do don't enter their payables in advance; they do it when the checks are cut."

Luhring thinks QuickBooks is good for short-term cash forecasting, but not long-term. "All QuickBooks does for you is say, 'Here's what your payables are, and here's what invoices you've sent out, and I'll add 30 days to that, because I assume that's when you'll receive the money.' You can't even enter your idea of what sales are going to be for the next six months."
Option #3: Use SurvivalWare.
"SurvivalWare is a software package designed to do short-term cash flow forecasting, and nothing else," Luhring says. "There are separate tabs to enter your sales forecast, open invoices, payment obligations, credit card data — balances, rates, and limits — and special events."

The software creates a simulation, and generates graphs to show which weeks have shortfalls and how much. There is one overall measure called the PP Score — it stands for "probability of meeting payroll — which tells you at a glance if you're in trouble or not.

"If you are operating close to the edge, SurvivalWare offers some tools to help you figure out how to muddle through," Luhring says. "For instance, you can mark several payments and command the software to slip them all by several days — or weeks or months — or break them into pieces. You can do the forecast with or without the assumption that you will use your credit cards to make up the shortfall."

The advantage of a tool like SurvivalWare is that it's built for the task at hand, and does most of the work for you. Plus, there's an import feature to pull in your open invoices from QuickBooks or Great Plains. Also, Luhring says it's the only program he's found that will handle the uncertainty of when sales are made, and when the cash comes in.

The big disadvantage: To use SurvivalWare effectively, you have to provide a lot of detail. "You have to give precise dates and amounts for all your planned expenditures for a three- to six-month period," Luhring says. "Most companies don't want to go to all that trouble unless they're close to the edge."

What this means: You need a complete list of invoices and list of payables, plus your expected expenses for next six months, plus all credit card details, plus your sales projections, ranked in a range of low to high probability. That may sound like a lot of work, but for a firm with cash flow risks — like Luhring's clients who financed his software company with $300,000 charged to 15 different credit cards — it's worth it.

Cash flow management tips
Rusty Luhring has been writing financial planning software since 1979, when he was founded his first software startup, Ferox. SurvivalWare was born in 1996. During that long tenure with client companies large and small, Luhring has picked up lots of tactical experience. Here are his 13 top tips for avoiding and managing through cash crunches:

Tip #1: Get your invoices out on time. "Follow up and call, if you have to," Luhring says. "Speed up collections however you can — though you never want to sound like you need it."

Tip #2: Offer a discount for early payment. "This is especially true if you're working with big companies; their payables departments are sometimes required to take early payment discounts."

Tip #3: Invoice more frequently. "If you're billing customers for time, consider billing twice a month instead of once," Luhring says. "Billing promptly on the 1st and 15th of the month speeds up immediate cash flow."

Tip #4: Ask for money upfront. "Instead of just billing for time as it is incurred, ask for a third up front, a third while the job is in progress, and a third upon completion."

Tip #5: Fine-tune the timing of your payables. "Take advantage of the maximum allowable time to pay your suppliers — usually 60 to 90 days," Luhring says. "Picture it as an interest-free line of credit that gives you more time to collect accounts receivable without spending money on short-term credit lines. If your payroll withholding taxes are less than $50,000 per year, remit the withholding on the 15th of the following month, instead of three days after payday."

Tip #6: Keep track of where you are. "You should know your cash balance, your current obligations, and your monthly burn rate," Luhring says. "When you're healthy, a monthly check is good enough; when things are close to the edge, you need to know weekly."

Tip #7: Be honest with your creditors. "Don't make commitments just to get them off the phone," Luhring says. "Rather than hiding from the problems, you've got to meet them head-on. Sometimes, your good relations with creditors is the only thing to keep bankruptcy at bay."

Tip #8: Move slowly on expansion. "People eat up cash flow faster than any other line item," Luhring says. "Whenever you hire someone, sales drop off — it seems to be part of Murphy's law."

Tip #9: The only guarantee of healthy cash flow is sales. "In the last few years, many startup companies paid more attention to raising capital more than they did to sales. They learned the hard way."

Tip #10: You always need more cash than you think. "When I look at any new business plan, I always contend that whatever they've put down for capital requirements is the absolute minimum they'll need," Luhring says.

Tip #11: Borrow money before you need it. "If you're desperate for cash, it's too late to get a loan," Luhring says. "Build those relationships, and arrange a credit line when you have some cash available."

Tip #12: Manage your credit cards. "Many credit cards offer a cash advance credit limit that's lower than the overall credit limit," Luhring says. "When things get tight, make sure you charge expenses to those cards that still have available merchandise credit, but no available cash advance credit. During a cash flow crisis, you want to maximize your available cash advances — they're almost the same as cash."

Tip #13: Consider layoffs. Okay, it's an ugly subject, but Luhring suggests there's a compromise: "Instead of letting staff go entirely, discuss rehiring them as freelancers. It reduces the costs of health insurance, payroll, and stock options for you, and gives them the freedom to seek out additional work from other companies to boost their income."

Another good resource on this topic is a report called "Managing Cash," sponsored by MasterCard, available online as a 10-age PDF. It's well-written, very detailed, and offers lots of good examples.

Case study: Software cash flow crisis
We asked Luhring for a real-life example of a software company that had recently weathered a cash drought, and how they analyzed and managed the rain-making process.

One of his customers agreed to tell their story publicly, but, after looking at their fairly scary reports generated as recently as February, asked that we not use their name. We understand how important the public perception of solvency can be, so we agreed to run their story masking the company and product names.

Here's the case study, with reports from SurvivalWare. (Again, we're not pushing Luhring's application, but the graphs it produces, embedded here as PDFs, make the case study a lot easier to understand.)

It was the summer of 2002. Acme Software was at a crossroads. The company had gone into debt to make the transition from being a custom programming shop and a Microsoft Certified Partner to become the publisher of a Web-based widget-tracking software package.

Their package, WidgetWare, seemed to be building momentum in the marketplace, and continued to win accolades from customers. The Acme founder and CEO felt that he had a goldmine, and did not want to dilute his 100% ownership of the company at this critical juncture.

Yet the debt load of the company was worrisome. The CEO had never been late with a payment to vendors or lenders, but it seemed that lately he had to borrow from his credit line every few weeks to meet payroll.

He had just received another solicitation in the mail to borrow $20,000 at a low rate, but it carried some severe penalties if he was ever late with a payment. Plus, he had to borrow the full $20,000 — it wasn't a credit line. The CEO's big problem was that he didn't really know close to the edge he was.

He heard about SurvivalWare from a colleague, and agreed to be a beta tester for the new 32-bit version that would handle his numerous credit lines.

The first step was to do some basic financial analysis and look at his collection cycle. SurvivalWare did a calculation that shows collections had been running 40 to 50 days over the last several months. (See Figure 1.) That was slower than he thought. He had assumed everyone was paying in 30 days or less.

The next step, to get a fix on how much cash would be needed for the rest of the year, was to do a cash flow projection assuming he'd tap no additional credit lines. Figure 2 shows the result: another $40,000 would be required. If the credit lines gave out, he would be in serious trouble by the end of the year.

Acme's CEO did one more projection, this time allowing the existing credit lines to be tapped as needed. (See Figure 3.) This let him make it through the end of the year, but barely. He decided to accept the $20,000 in additional credit, and to go to work to improve his collection cycle by increasing the percentage of sales that were paid by credit card instead of by invoice.

An updated forecast in February of 2003 shows that the company has been improving both its sales and cash flow. Figure 4 shows a statistical forecast of WidgetWare license sales for the next several months based on sales history. Pay-per-click advertising started in March, 2002, and you can see its effect on sales from April 2002 forward.

Figure 5 shows an updated cash forecast — assuming that Acme does not tap its credit lines. A sea of purple in the upper right quadrant — the probability of meeting payroll, or PP Score — is a good thing.

The bottom two bar charts show how much is cash needed conservatively (90% confidence) and with luck (50% confidence). It looks like Acme will be able to get through the next four or five months with another $15,000 in borrowings — or, with luck, none at all.

Figure 6 confirms that things are okay by factoring in the credit lines. There is not a huge amount of cushion, but there is life-sustaining cushion nonetheless.