Manage to cash.
Of the god metrics of ecomm, Zeus = Cash. Contribution Profit sits at Cash’s feet.
Companies don’t go insolvent because they run out of Contribution Profit. They go insolvent because they run out of cash. You pay your suppliers and vendors in cash. You pay your people in cash. You pay your lenders in cash. You distribute cash to yourself.
Contribution Profit is important as a proxy metric for understanding how to generate more cash. But it’s NOT your north star metric.
A couple years ago everyone talked about revenue. Now they talk about contribution profit. They are getting more right, but they still aren’t right enough.
Contribution profit just tells how much cash should show up from a given product sale or aggregated sales. But it doesn’t tell us when that cash is coming in and most importantly, when it has to go out.
Obsess over your ability to generate cash.
The #1 lesson operators should learn from from others’ failures:
“Manage to cash, but report to GAAP.”
- James Shein, Reversing the Slide
Shein is a professor at Northwestern’s Kellogg School of Management and a corporate turnaround specialist. I found his book in a roundabout way. I listened to @mehtab on the The Operators podcast episode 9 which then prompted me to read Mehtab’s post about Karta Ventures and in it he mentions Jeff Sands (@Turnaroundartst) book, Corporate Turnaround Artistry and James Shein’s Reversing the Slide.
What’s clear in both books is how precariously close companies come to the zone of insolvency without realizing it.
The zone of insolvency is a legal term which courts will interpret in different ways, but common tests include:
- a company’s liabilities exceed the market value of its assets
- a cash flow test that determines whether the company has the necessary cash flow to meet its financial obligations
- a capital test of whether a company has the necessary capital or access to capital to support operations
Tripping covenants, overdrawn revolvers, chronic liquidity problems or knowing it can’t make future debt payments are all sure indications a company is in the zone of insolvency (credit: James Shein, Reversing the Slide).
Tests 2 and 3 are most relevant for brands. What pushes companies into the zone of insolvency and then down the ‘distress curve’ as Shein describes it, is inability to generate sufficient cash which leads to inability to access capital.
You don’t go insolvent and into distress because of lack of Contribution Profit. You go there because of lack of cash.
So manage to cash, report to GAAP.
The 13 Week Cash Flow Model
The critical tool in managing to cash is the 13 week cash flow model.
As Shein, Sands and Mehtab all forcefully show, it’s the critical tool in turnarounds.
But even if you are not in turnaround or distressed, the 13 week cash flow model should be central in your day to day. Brands are cash intensive. And omnichannel brands have a different cash cycle for each channel. For DTC, you receive cash in a couple days from sales. But in wholesale, you may have extended payment terms from a big mass retailer, but do they pay on time, consistently late or you aren’t sure? Knowing where you stand today, this week, this month and this quarter in terms of cash is absolutely critical.
Your outgoing cash is critical to get right too. Maybe you can extend some suppliers. But others like Meta (if you can get credit terms) will give some slack, but then shut you down. If you have debt with fixed payments, then you likely have covenants. Not understanding where you are and will be with cash can cause inadvertent tripping of covenants.
A friend once closed on some subordinated debt and used some of the cash to pay a bunch of suppliers. While the right idea, they dramatically lowered the cash balance before more incoming cash and tripped a covenant. The lender was ultimately understanding, but tripping a covenant in your first month or two after closing is not how you want to start your relationship.
And your biggest cash concern is payroll. Get cash wrong and you can quickly move from the zone of insolvency to a forced liquidation or bankruptcy.
A monthly model or P&L does not have the granularity needed to manage cash properly. Your monthly P&L or model nets the incoming and outgoing cash in the same period. But as you know from the experience of watching your bank account, that’s not how cash actually works. I have seen models where they try to hack the cash projection by subtracting big cash outflows like inventory from EBITDA. Don’t do this.
Manage to cash using a detailed 13 week cash flow model and build the necessary processes to keep this accurate. This importantly includes checking your model’s projections against reality and making the necessary improvements to ensure high accuracy.
Once this muscle is built inside your org, extending the cash flow forecast out to 26 weeks and eventually building a strong cash flow projecting model several months into the future is essential for making the right capital decisions.
Use your monthly 3 statement model for longer term strategy and scenario planning. But don’t try to rely on it for managing the day to day, week to week or even month to month cash flows.
You can build your own 13 week cash flow model, but if you want a template or headstart, here are some free ones.
eCommerce Fuel
@AndrewYouderian at eCommerce Fuel has a nice template and helpful guide for setting up your own version.
https://www.ecommercefuel.com/cashflow-forecasting/
Jeff Shein’s model is the most comprehensive I have seen. I don’t know if it’s a class exercise, but the formulas don’t seem to get copied over so you will need to do some work before you use it. That said, it’s a good template for someone on the team unfamiliar with how to set up a good 13 week CF model and maintain it. It has helpful notes in the model.
https://reversingtheslide.wordpress.com/supporting-materials/
@eric__andrews is a wealth of information. He has a ton of good and helpful videos and offers courses as well.