How Long Is Your Runway?

runwayAs a pilot I love it when I can draw aviation analogies and experiences into my entrepreneurial life. Perhaps the most obvious comparison involves the “runway” metaphor.

Most of us appreciate that the numbers we drafted in our start-up business plans are (let’s face it) rather meaningless. How can we possibly predict several years worth of revenue and cost data when we are still testing our initial business hypothesis? We simply cannot – but that doesn’t mean we shouldn’t have a plan. Cashflow distress is one of the leading causes of business failure. I’m not too proud to admit that I experienced a “near miss” myself in the past. Here are some tips to avoid a plane wreck.

The good news is that a cashflow crisis is entirely avoidable, if you have a robust planning and reporting process. Obviously, one of the goals of business is to generate a profit, but even profitable businesses are not immune from cashflow problems. If your bill payment cycle is out of sync with your revenue cycle, be wary. If you operate a web-based business, you have a particularly lumpy cashflow because your payment gateway provider may only pay you monthly initially. After a period of trading it is generally possible to negotiate weekly payments. Arrange this as soon as possible.

For other kinds of businesses, the chief risk is aged receivables. In other words slow payers. You aren’t a bank, so why should you loan precious operating capital to your customers?  Which is effectively what you are doing. There’s no law that says customers only pay on the 20th. For consulting or services work, I generally apply terms of 10 working days. Make sure you discuss the terms up front however, so everyone is on the same page. If they can’t be flexible – is that the kind of customer you want to be involved with?

Even if you don’t know exactly what your revenue is in advance, make an intelligent guess based on past experience. But be conservative. A cashflow forecast is quite possibly the one tool that will keep you out of the shit. Figure out your burn rate and balance this against cash on hand and income. That’s how you work out your runway. You should be able to forecast how much cash will remain at the end of each week, at least a few weeks ahead, preferably more. Initially this is tough, but it becomes easier as you collect more data.

Most businesses start out under-capitalised. Provided your business model is sound and revenue starts flowing early, this is not always a problem. But the reality is that under-capitalised businesses fail more often and grow more slowly due to less investment available for growth initiatives. If you are worried about excessive burn rate there are only two possible solutions. Sell more product or reduce outgoings accordingly. Unfortunately salaries are usually the first target, so be realistic with your early employees or co-founders and be clear about what the options are if cashflow drops.

Paul Spence is a commentator, technology entrepreneur and is a co-founder of iwantmyname, a New Zealand based global Internet venture. You can follow him on Twitter @GeniusNet

 

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