Four years ago, when I co-founded The Baby Einstein Company with my wife to develop products for introducing young children to classical music and the arts, we took a page from an artist from another musical venue: folk legend Bob Dylan.
Dylan was once quoted as saying: "Money talks, cash screams."
Indeed, it does. So my wife, Julie Aigner-Clark, and I decided we would launch and operate our company entirely with cash generated by the business. One reason was that in my previous life, as founder of a developer of learning software in the early 1980s, I struggled through the experience of dealing with a venture capitalist. Julie lived through it with me and wanted to avoid a repeat experience at all costs.
Another reason was that by doing it ourselves - with initial funding of $10,000 from our savings - we would be in control of both our professional and personal lives. As parents at that time of an infant and a toddler, we would be spared the long hours of tense meetings and having-to-answer-to-them sessions. We would manage our time as we saw fit, sleep easier at night, and be independent.
Not that it would be easy. In shunning bank debt, private placements and venture capital - and we were offered venture funding three times during the last two years - we knew we would have to wrest control of our cash, budget carefully, and adjust immediately when our spending began getting ahead of our revenue.
Our Results, Your Challenge
Within the four years, we've turned our initial shoestring investment of $10,000 into a company with projected annual sales of $17 million. The value of its equity is now so attractive that we were recently able to put the company up for sale.
More to the point, we believe that the all-cash principals we have practiced are applicable to other fledgling enterprises and can be embraced by all entrepreneurs, as we feel they should.
In short, cash reserves are perhaps the most powerful competitive advantage a small-business owner can possess. With surplus cash, the founder can plan and quickly execute on plans for building the company, and deftly weather unforeseen difficulties, whether acts of God, government, the economy, or competitors.
For entrepreneurs launching or operating companies, doing business the all-cash way involves adhering to guidelines for managing cash, budgeting for expenses, and adjusting when the two aren't in synch.
What follows are the rules, which we've honed during our years of building The Baby Einstein Company.
Start With Costs
A lot of fledgling entrepreneurs start planning for their companies by projecting revenue and determining from that figure the amount of money they can spend to hire staff, develop products or services, and determine marketing activities. At Baby Einstein, we've discovered that the reverse is more appropriate for the all-cash way of operating. Costs are controllable, revenue far less so. The mandate? Nail down those costs!
At Baby Einstein, Julie and I ran the business from home during the first several years. Not only did that make it easier for us to combine building a company with caring for two babies, but we were also able to keep our overhead low.
Another tactic involved watching manufacturing costs closely: ours were budgeted at 16 percent of our wholesale price, eight percent of retail. For the first two years, we sold to only three wholesalers and turned over our inventory 20 to 24 times a year. As a result, we were able to generate a large base of accounts receivables, an asset that would produce a growing cash reserve for the company.
Cash being our mantra, we didn't leave matters to chance. Added to our costs, as a line item in our budget, is a "cash reserve." Much like a savings account for households, this "surplus" cash is our buffer against hard times or surprise opportunities.
Set and Stick to a Budget
With a firm grip on costs, the all-cash way involves turning next to the task of projecting revenue. Be sure to set those revenue numbers without looking at costs - and then cut them by 10 percent just to be conservative.
When costs and revenue estimates have been determined, it is time for the central task of managing cash: that of setting and managing to a budget. Setting a budget means bringing costs in line with revenue projections. If the estimate doesn't meet the goal determined for profit, start paring costs.
At Baby Einstein, we put our marketing programs on trial for their lives every quarter. We have cancelled trade shows, advertising placements, and direct-mail campaigns when costs have risen against revenue. Twice, we've fired our public-relations agencies, and twice again, we've deferred releasing new products for six months.
Another tactic we use is to pay our bills within 20 days, in exchange for getting exceptional prices from our suppliers. Videotape duplication of our products comprises the costliest item in our budget. We've changed vendors for this service twice, each time securing a better price.
Adjust for Reality
At every step, when using the budget as a management tool and matching costs to revenue, let the numbers "talk" to you. Individual numbers and the relationship between numbers describe the health and direction of your business.
Having majored in physics in college, I've been trained to recognize when numerical relationships don't "add up." For example, when current assets minus inventory are divided by current liabilities, the ratio makes no assumptions about whether the inventory can be sold - and neither should a business owner. The only variable - and the only item to which the owner can attend - is collecting on accounts receivables.
When the numerical (or other) signals suggest bad news, don't ignore those signs and hope for the best. Instead, take action and adjust your operating agenda. If you need to cut costs, make that "cash reserve" line - your emergency savings account - the last rather the first item to go.
At Baby Einstein, we once had two major retail chains go bankrupt and a third slow their payments to us to 120 days from 60 days. We immediately analyzed these developments, exploring the ramifications for our competitors as well as our company. Our solution was to lower our prices to the troubled chains during their time of need, while simultaneously reconfiguring our product line to appeal to and thus open a new distribution channel.
Meet the Challenge of Fast Growth
Another adjustment challenge involves providing for cash needs when a company is growing rapidly. The objective here is to turn inventory as rapidly as possible, while keeping revenue projections conservative. Inventory, as we say at our company, is "frozen cash" sitting on a warehouse shelf waiting to begin its journey from goods to account receivable to cash.
During a period of rapid growth, inventory and accounts receivable are also likely to be growing, putting pressure on a company's cash. Balancing the need to make additional investments to buy inventory and hire people to provide for growth with the need to spend less cash than the company is generating becomes the ultimate cash-flow challenge.
It's at that point that a business must reconsider its cash-flow strategy. If it has built enough cash reserves, it will be able to turn to its own coffers to finance growth. If not, a bank or a venture capitalist is likely to become the company's new partner.
With growth having become a sort of business Holy Grail, it is likely that not all companies evaluate the real costs of growth and determine what is right, both for the company and an owner's personal goals.
We recently faced this very question at The Baby Einstein Company.
We had built an extremely profitable brand that could be taken to the next level of growth. In spite of our deep cash reserves, we realized that we would have to raise investment capital to get to the next level. Being true to our goals, we didn't want to do that. By deciding instead to put the company up for sale, we opted to harvest the value we created while transferring the challenge of financing growth to a new owner.
In listening to our own numbers, we heard cash scream the answer that made the most sense for us.