Survival = Profit

Most entrepreneurs I meet confuse cash with cash-flow. They are two different things.

In the early stage, company entrepreneurs invest cash in the business to cover expenses like inventory or marketing in anticipation of demand. Forecasting demand accurately is often more like a guessing game. A time period passes before actual sales take place, and a further time period before revenue comes in. It’s the time period between when cash flows out and back in that causes the issue. Cash flowing out to vendors and manufacturers can be fairly immediate, they are not obliged to be patient over payment. Cash flowing in from sales, however, can take longer to show up and often comes in unpredictable waves.

My favorite cash-flow anecdote, to demonstrate the issue, concerns an entrepreneur named Adam Osborne. After selling his successful computer-book publishing company to McGraw Hill, Osborne started a personal computer company called, the Osborne Computer Corporation. He used $100,000 of his profits and a loan from a venture capitalist of $40,000.

Founded in 1981, the company sold their first inexpensive portable computer. The Osborne 1 weighed 24 pounds and was the size of a sewing machine – in fact it looked a bit like one. It had a carrying handle and could fit under an airplane seat. It could not be used in-flight, since it didn’t have a battery, but executives finally had a way to take their office files with them.

Dealers were enthusiastic and the first units shipped in June 1981. In August 1982, the company sold $10 million worth of computers and by February 1983, its sales on the books reached $100 million. By all measures, the company had the fastest growth in computer sales history.

In 1983, Osborne announced several next-generation computer models, which had not yet been built, highlighting that they would outperform the existing model. Sales of the Osborne 1 fell as sharply as they had risen, customers anticipated those more advanced systems and cancelled their current orders. Faced being stuck with a mountain of suddenly unwanted and obsolete inventory, Osborne reacted by drastically cutting prices on the Osborne 1. But customers didn’t want to buy an inferior model, no matter how discounted.

The first high-profile evidence of trouble at Osborne Computer came in June 1983.  InfoWorld published a story saying the company was suffering from cash-flow issues and delays with the new machine hurt Osborne 1 sales. By then, layoffs had begun. In July, the Journal published another story on Osborne’s plans to go public, saying financial woes had forced the company to give up on them:

‘Sales of its Osborne 1, a best seller in 1982, fell off sharply in the spring, when the offering was to have been made, forcing the company into a cash squeeze. Osborne Computer’s main problem has been the timing of its introduction of a new portable computer this spring. Dealers cut off orders for the Osborne 1 to wait for the new machine, but it was behind schedule.

“We had an April with no income,” says Adam Osborne, the chairman. The company was also coming out of fiscal 1982 with flat results or a loss, and competition from newcomers in the portable-computer business was intensifying. Osborne takes the blame for the introduction snafu.’

This market event, a pre-announcement of a new product causing a drop in demand for older ones, is now known as “The Osborne Effect.” The real reason for Osborne Computer’s bankruptcy in September 1983 was actually poor cash-flow management. Looking back, Thom Hogan, an executive at Osborne Computer attributes their failure to:

“Cash-flow, basically… and decisions relating to it. The company was undercapitalized from the beginning, so the very rapid growth essentially had us ordering more supplies every month faster than we were taking in money on the income side. The company would have sold even more than we did with more capital. Basically it was “buy as much new parts and add as much staff as we can afford” every day. I can’t remember a month where the cash-flow numbers looked great, despite the profitability numbers looking decent.”

Depressing perhaps, but with our mirror neurons fully functional we can observe, learn, and avoid similar errors. It’s essential to understand that while cash is king, cash-flow is the issue for everyone large and small. Many people underestimate the cash cushion they need to get through the rollercoaster ride of the first couple of years. The years when sales and revenue can lag significantly behind cash investment and cash expenses. An error that is easily corrected if you ensure you have access to extra capital from the start. For many small businesses a simple line of credit could have saved them.

It’s because of these stories and thousands like them that I have approached all my companies with the same set of beliefs: