Shane, whose name we've changed to protect his privacy, is a successful business owner with a problem. He has established three businesses ranging in size from $1 million to $8 million in revenue. Each of his companies has a general manager with stock options, so should Shane sell one of the businesses, the manager will benefit financially.
One of Shane's managers–let's call her Diane–has been building a promising product that has required Shane to invest a lot of his excess cash to bring the product to the point of commercialization. Shane has already lent Diane's company more than $700,000, and Diane estimates it will cost another $500,000 to become cash-flow positive.
Diane would like Shane to lend her the $500,000 at prime plus three, but Shane's not comfortable pouring another half million dollars into her business. The business could never qualify for traditional bank financing, and it is too early to attract an outside investor, yet Diane continues to treat Shane like a bank with an open door and a bottomless supply of money.
Now Shane is in a tight spot: if he lends the money to Diane, he risks becoming overextended. If he refuses, Diane's business will likely go bankrupt before rounding the corner to profitability, and Shane will lose both his start-up investment and the $700,000 he has lent the business.
One of the problems, in my opinion, is that Shane has given Diane only one side of the entrepreneurial equation – options that will make her rich if Shane sells–but Diane faces no downside (other than being out of a job if the company goes bankrupt) for sucking up Shane's cash. I think it's a common problem for entrepreneurs with multiple businesses and general managers who lack a basic understanding of cash flow.
Cash flow is like oxygen. If it runs out, nothing else matters. Smart operators, using their own money, have a funny way of being able to stretch every dollar. They ask customers to pay up front, extend their suppliers, tighten their manufacturing process to build on demand–they do just about anything to preserve their cash.
But Diane is not acting as though it's her money. She could have asked a prospect(s) to pay in advance for an unfinished product in return for the opportunity to influence the product's design. In this kind of arrangement, the customer gets a product that is designed to meet its specs, and the entrepreneur gets the cash needed to commercialize the product. It's how Bill Gates got the money to get the first Microsoft operating system off the ground. He agreed to develop the product that would evolve into Microsoft Windows with IBM as the financier and first customer. IBM got its operating system, but Microsoft retained the copyright, and the rest is history.
Being responsible for cash flow has a way of sharpening a manager's focus and turning the game of business into real life.
This is why I use a cash flow statement to mark the edges of the playing field for a general manager running a business for me. I have a cash flow statement generated each week and make sure the operator maintains an agreed-to minimum cash balance.
Cash flow is not the manager's goal–usually I tie a goal to profitability or client retention–but it marks the outer limits of the playing field. Cross the line, and the game stops. I state clearly that if the operator goes outside the lines, it is grounds for immediate dismissal. That might sound harsh, but it is no more cruel than the real world, where the owner who runs out of cash is out of business (and probably homeless). There is no second chance when it's your own company.
By making your general manager responsible for both profits and cash flow, you align your interests–both the upside and down–as closely as possible.