Today, I am reviewing my basic financial management textbooks. Going back to the very basics of the statement of cash flows, I was struck by the reminder that a profitable company can still declare bankruptcy if they are not careful to build up their cash from operating activities. "Cash is King!" was ingrained in our studies in B-school. Unfortunately, though, some startups with financial backing from either Angel investors or VC's may forget the basic cash principle, because they sit back comfortably in their security cushion thinking that it will always be there to protect them. If they run out of cash they can just go to their investors and ask for more, right?
The reality is that we do live in an investment world that allows for people to build castles in the sky (I give credit to Burton Malkiel's "A Random Walk on Wall Street" for my use of this expression, although I don't know if he coined it in this context.) These are businesses that have negative cash flow, no obvious potential for generating revenues, but that manage to be purchased for sums that make no sense to the foundations of finance. Remember when Color.com received $41 million dollars in investment funds? We're still not sure how they are going to make a profitable return for their investors. Maybe Color.com will wow the World, as Groupon did. Maybe it will just become another dot com. Only time will tell, but stories such as theirs make some young entrepreneurs forget the basic formula of building a product or service, selling said product or service, and collecting money from their clients. This age-old formula continues to be the best way to build a business. Making a profit isn't even enough. Having a positive cash flow on operations is precisely where a business needs to arrive. In other words, make deals, sign contracts, but make sure to get paid. Personally I would hope this would wow many more investors. Unfortunately, there are too many out there who are investing less in good businesses than in the psychology of the markets.
The reality is that we do live in an investment world that allows for people to build castles in the sky (I give credit to Burton Malkiel's "A Random Walk on Wall Street" for my use of this expression, although I don't know if he coined it in this context.) These are businesses that have negative cash flow, no obvious potential for generating revenues, but that manage to be purchased for sums that make no sense to the foundations of finance. Remember when Color.com received $41 million dollars in investment funds? We're still not sure how they are going to make a profitable return for their investors. Maybe Color.com will wow the World, as Groupon did. Maybe it will just become another dot com. Only time will tell, but stories such as theirs make some young entrepreneurs forget the basic formula of building a product or service, selling said product or service, and collecting money from their clients. This age-old formula continues to be the best way to build a business. Making a profit isn't even enough. Having a positive cash flow on operations is precisely where a business needs to arrive. In other words, make deals, sign contracts, but make sure to get paid. Personally I would hope this would wow many more investors. Unfortunately, there are too many out there who are investing less in good businesses than in the psychology of the markets.
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