Startups and emerging growth companies face a challenging fundraising environment, where sources of capital from traditional sources have slowed dramatically.
In these conditions, companies must become more thoughtful and disciplined in managing their working capital. CFOs play an important role in working capital management, in both a tactical and a strategic capacity.
Here is how we work with our clients to help them manage and conserve their working capital.
What is working capital?
Working capital is simply the cash needed to operate the business, whether meeting payroll, buying inventory, or investing in product development. The size of a company, its relative maturity and perhaps most importantly, its business model are the primary drivers of a company’s working capital needs.
Experienced CFOs manage three variables in working capital: cash inflow, cash outflow, and time. The third element — time — cannot be overlooked.
When assessing the adequacy of working capital, the critical metric is not the total amount of working capital, it’s how much time that working capital will keep the company in business.
Managing cash inflows and outflows often involves strategies that accelerate the timing of inflows and slow the timing of outflows.
First role of the CFO: monitor and report working capital
The first role of the CFO is tactical, to monitor the cash position and be able to provide a clear, timely understanding of how much working capital the company can access.
This metric usually is expressed both in terms of raw numbers. For example, “you have $300,000” in the bank or in terms of runway, “you have six months of runway.”
Both metrics are important, and both are relative. A “good” cash position is relative to how much the company is spending, the size of the business, debt service levels, and other financial circumstances.
When serving this tactical role, the CFO must have systems in place that allow for the accurate reporting of working capital at any given point in time.
For startup and emerging growth companies, the finance team must be able to report on the company’s working capital position with absolute certainty, and the reporting should be flexible enough to quickly play out various scenarios such as the inclusion or exclusion of certain future events.
For example, if the company is negotiating a large sales contract or considering hiring another engineer, then the CFO must be able to project working capital under the various scenarios.
Strategic role of the CFO: choosing options for maximizing working capital
Many startup and growth stage company founders typically focus on investment capital as a primary means to improving working capital.
But equity raising is not the only source for generating working capital, and being able to deploy other working capital strategies is just as vital to a company’s success, particularly in tight fundraising markets.
The CFO has many tools at his or her disposal to maximize working capital, including:
- Negotiating payment terms with customers and suppliers.
- Cutting back or furloughing employees.
- Using grants of common stock or stock options to compensate management teams or pay key vendors or service providers.
- Raising funds through convertible debt or SAFE agreements, which are much quicker and less expensive than traditional equity funding.
- Factoring receivables.
- Obtaining loans.
Often, deploying a combination of approaches is the best strategy to maximize working capital while minimizing risk.
Choosing the right combination depends on a variety of factors, including the general business environment, the circumstances of the company, and management’s tolerance for risk.
All these working capital management strategies have pros and cons that must be balanced.
As a strategist, it is the CFOs job to identify and analyze the various combination of tools the company might use and make recommendations to management on the course of action that gives the company the greatest chance for success.
Working capital and the successful startup
Successful startup and emerging growth companies rely on effective working capital management, and the CFO drives that process, contributing both tactical and strategic expertise.