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Cash is King

Financing Your Business for Sustainable Growth

By Paul B. Finch, MBA  |  5/20/2019

Most growers and producers in the wine industry pay a great deal of attention to the processes necessary to develop a quality product and bring that product to market.  However, these same growers and producers often fail to give equal consideration to the financing needs of their business, specifically, the financing necessary to sustain the growth of operations.  Businesses can fail for many reasons, but the common denominator for most business failures is that they run out of cash.

Profit Does Not Equal Cash

So why is this the case?  One of the primary reasons is that owners and managers (and sometimes boards) are taught to focus on Income Statement measures of Profit such as Gross Profit, EBITDA and Net Profit.  They make the mistake of thinking that measures of Profit are the same, or equivalent to, measures of Cash.  This is often not the case and can be a fatal error in thinking for both new and established business entities. 

There are essentially five reasons why Profit Does Not Equal Cash:

·         Revenue is recognized [booked] when it is Realized and Earned – this is often different, under the accrual standard, than when payment is actually received.

·         Expenses are recognized when matched with Revenue [for Cost of Goods Sold] or when incurred [for Sales, General & Administrative Expenses] - this is often different, under the accrual standard, than when an expense item is actually paid.

·         Depreciation, Amortization, Deferred Revenue and Deferred Taxes are “non-cash charges” – While these transactions reduce Profitability, they do not decrease Cash Flow.

·         Loan and Notes Payable/Receivable are booked on the Balance Sheet – these transactions do not increase/decrease Profit [Loss] but do increase/decrease Cash Flow.

·         Working Capital must be financed – This financing requirement is not contained on any financial statement.  It is hidden from view but will be inadvertently funded by short-falls in Cash Flow if not managed appropriately.

Unlike Profit, Cash “is cash”, it is a metric that can be neither distorted nor subject to interpretation – its meaning is self-evident. Understanding the amount of Cash that is required to finance operations [now and in future periods] is essential to sustaining growth. This is why Cash is King.

The following are the steps I take when advising my clients as it pertains to achieving/obtaining the business financing necessary for sustainable growth:

 

 

Step 1: Secure Proper Financing for Working Capital  

Working Capital is a term that is often discussed but seldom understood. Working Capital, as derived from the Balance Sheet, is traditionally defined as Current Assets minus Current Liabilities – that is cash and cash equivalents less a business’ immediate obligations [usually those due within a year or less].  Unfortunately, this traditional definition does not help owners and managers determine the Cash component of Working Capital fundamentally necessary to finance operations.  This required financing is resultant from the timing spread between Inventory and Accounts Receivable conversions to cash and off-setting Accounts Payable deferrals of cash, otherwise referred to as the Cash Conversion Cycle.  Accordingly, it is essential to maintain a quantifiable amount of Cash [on Hand] necessary to finance a firm’s Cash Conversion Cycle. Additionally, owners and managers need to be aware that their requirements for financing the Cash Conversion Cycle will increase over time in proportion to the growth in their firm’s revenue

Step 2:  Secure Proper Financing for Capital Expenditures

In the wine industry, Capital Expenditures are the investments necessary for production.  Typical Capital Expenditures are (i) land, (ii) buildings [including tenant improvements] and (iii) equipment.  These Capital Expenditures are usually significant investments and must be depreciated over the useful life of the asset and, therefore, distort the difference between Profit and Cash on Hand.  Accordingly, it is often desirable to finance Capital Expenditures in order to preserve the Cash on Hand required to finance the Cash Conversion Cycle referenced above.

Step 3: Examine Your Capital Structure

It is important to understand how and when to properly utilize Debt and Equity when financing operations [otherwise referred to as the Capital Structure of a business].  As it pertains to Debt, this typically means (i) Revolving Lines-of-Credit to fund the Cash component of Working Capital, especially for growing, cash-starved businesses, (ii) Capital Leases for the acquisition of production equipment, with a term closely matching the expected life of the asset, and (iii) Term Loans for the acquisition of land and/or tenant improvement projects.  The proper use of Debt in a Capital Structure can prevent the unnecessary dilution of Owners Equity, through otherwise unnecessary owner contributions and, as such, can serve to optimize the value of Owners’ Equity as well as increase Return on Investment.

As it pertains to Equity, this typically refers to an owner contribution for Start-Up Expenses as well as any Inter-Period Net Losses that may be incurred by the firm.  Additionally, Owner Contributions may be necessary to “balance” a Capital Structure, which entails maintaining minimum Debt to Equity Requirements as necessary to comply with banking covenants and conditions.

Additional Thoughts

I am additionally recommending to my clients that they actively engage in business planning, in the form of budgeting, looking forward over the next two to three years while taking into consideration the Working Capital and Capital Expenditures necessary to support projected sales/revenue growth.  Budgeting is especially important for growers and producers as a means to predict the Cash investments in their business which will be necessary to support projected operations and sustainable growth. 

Paul B. Finch, MBA, is co-founder and Executive Director for Benchmark Solutions (www.benchmarksolutions.us.com).Benchmark Solutions, Inc. is a boutique business advisory which provides high quality corporate finance and management accounting services to some of the most innovative and creative businesses and emerging companies in the beverage, healthcare and technology industries. Paul specializes in the areas of Business Planning, Business Valuation and Business Optimization. You can contact Paul at paul.finch@benchmarksolutions.us.com