How long can a company lose money without running out of cash?

Only when the tide goes out do you discover who’s been swimming naked.
– Warren Buffet

Is the Houston economy’s metaphorical “tide” going out?  It’s hard to say, but some businesses are definitely feeling a bit “naked” these days.  They may not even realize the peril they’re in because they still have positive cash flow despite the fact they’re losing money.  This begs the question…

How long can a company lose money without running out of cash?

The simple answer to the question “how long can a company lose money without running out of cash?” can be found by using this equation:

Liquidity / Burn Rate = Timeline

… where Liquidity = the amount working capital of the company that can be converted into cash

… and Burn Rate = the amount of cash spent each month

This formula can be very helpful in projecting how much time you have to find a solution to turn things around.

Let’s assume you have $1,000,000 in working capital and are losing $100,000 a month.  According to the formula, you will only have 10 months before you run out of cash. The trouble is, you’ve predicted the downturn to last up to 18 months. 

Now what?

Managing “Crisis”

crisis with wordsThe character for the word crisis in Chinese is actually comprised of two other characters  – danger and opportunity The key to surviving, even thriving, during times of crisis is to find the opportunity amidst the danger.

Your first answer to the crisis was probably to cut costs.  Most likely, you’ve already done as much of that as you can so let’s look at some other ways to weather the storm.

Improving Productivity

One way to stretch your working capital is by improving productivityProductivity can be defined as:

Productivity = Throughput/Resource

 Examples of throughputs are hours worked, widgets produced, etc.  Resources are people, materials, etc.

 In order to improve productivity you must:

  1. Understand the processes – How do we do things around here?
  2. Identify and measure drivers – What’s really driving results?
  3. Identify bottlenecks & inefficiencies – What’s going wrong?
  4. Simplify the process – What can we cut out?
  5. Communicate to everyone – Everyone needs to be on the same page.
  6. Tie rewards to results – What gets rewarded gets repeated.

Improving Cash Flow

If you’re worried that you’ll run out of cash before things turn around, it’s time to focus on reducing your cash conversion cycle

Cash conversion cycle = DSO + DIODPO

Where:

DSO = Days Sales Outstanding

DIO = Days Inventory Outstanding

DPO = Days Payables Oustanding

Some of the ways to reduce your Cash Conversion Cycle are:

  • improving collections
  • invoicing faster
  • obtaining deposits
  • extending vendors
  • reducing inventory

Lastly, you must measure cash flow on a daily, weekly, quarterly and annual basis.

You can’t manage your cash flow if you don’t measure it!

Want a step-by-step guide to improve your cash flow?  Download our free tip sheet 25 Ways to Improve Cash Flow.

In order to measure cash flow effectively, you’ll need to take a look at your cash flow statement. On the cash flow statement, you’ll see three different type of cash flows:

  • operating
  • investing
  • financing

Operating

Your operating cash flows focus on the measurement of cash generated by your operations.  This is the most important cash flow type to look at when experiencing a positive cash flow and a negative net income. Because a positive cash flow is able to maintain current operations and potentially grow the operations, operating cash flow could be the main determinant in why you’re running out of cash in a positive cash flow period. If you’re experiencing this, you either are hiring personnel and can’t avoid it, OR you’re experiencing collections problems and/or have poor debt structure.

The bottom line of your operating cash flow determines whether your company will make a profit or not.

Investing & Financing

This type of cash flow deals with the cash flowing between the firm and its owners. For example, any technology investments or meeting requirements (payroll, etc.) would be considered investment cash flow. This type cannot be controlled like the operating cash flow due to the investment of necessary items.

If you’re experiencing this in your investing cash flows, look at your assets to determine if each asset is absolutely needed. The solution to an investing cash flow problem would be to sell some of these assets. In addition, consider raising capital to get over the hump.

In the end, you need to be mindful of where your working capital is going. Managing your cash flow is just as important as growing your revenue streams. To learn more ways to improve your cash flow, click here to download our free guide.

For more tips on how to manage your cash flow, click here.

The Strategic CFO
Strategic CFO Lab Member Extra

Access your Strategic Pricing Model Execution Plan in SCFO Lab. The step-by-step plan to set your prices to maximize profits.

Click here to access your Execution Plan. Not a Lab Member?

Click here to learn more about SCFO Labs

company lose money

, , , , , ,

No comments yet.

Leave a Reply

This site uses Akismet to reduce spam. Learn how your comment data is processed.