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This year, economic slowdown, inflation and war have combined into a cocktail that is now fueling fears of a recession across all business sectors, creating uncertainty for everyone from business leaders to investors to employees. Such uncertainty is forcing business leaders to re-prioritize and scale back their once ambitious growth plans. And with interest rates rising and valuations falling, more and more companies are returning to prioritize what was once the only way to ensure a company’s success: positive free cash flow.
All of this is a very strong reminder for all businesses, but especially startups and small businesses, that it is vital to build a business to make money in both good and bad times. Prioritizing free cash flow is the only way to cope with forces beyond your direct control.
Related: Never Worry About Cash Flow Again By Using These 5 Strategies
Positive free cash flow is not a luxury
Many entrepreneurs, especially when they start their business, start with a deficit. While this is expected (“You have to spend money to make money,” as the saying goes), too many companies, especially in the past decade, have spent too long in the unprofitable growth phase. Many leading companies in the technology sector are now faced with hard decisions with real consequences and disruptive effects, including drastic cutbacks in investment and layoffs.
This recent and all-too-common strategy of sacrificing profitability for growth can and has worked for some companies. Private and public capital markets facing a low interest rate environment are deeply entrenched in the high-growth segments of the economy to deploy their capital. This excess capital has disrupted the long-term corporate value drivers, that is, the relationship between the revenue growth rate and free cash flow margins. Given the valuation advantages, too many people have built their businesses solely for high growth at all costs.
For most companies, prioritizing profitability and free cash flow should be seen as the norm. Many business leaders may be surprised that this has no material impact on revenue growth.
Honestly, if you run a $100 million+ organization that just burns money, it’s a hobby. That doesn’t mean leaders shouldn’t invest in the company, it’s just a matter of prioritizing investments with the goal of generating positive free cash flow as well.
Businesses are meant to make a profit. While Wall Street has recently been exceptionally forgiving of growing but unprofitable companies, historically this has not been the case. With extremely low interest rates since the financial crisis of 2007-08, there have been little to no penalties for taking risks on high-growth but heavily cash-strapped companies. The phrase TINA – there is no alternative – came about as a result of the extremely low interest rates that provided a major incentive for investors to pursue growth without regard for risk, as they had few opportunities to achieve returns with a lower risk. However, as interest rates normalize, there are very real investment alternatives to high growth, and valuations for growth have dropped significantly as a result.
As we lean towards a “normal” economy as interest rates return to something approaching long-term historical levels, it’s time for business leaders to return to managing their operations for these “normal” times. Access to capital is now becoming more difficult and investors will demand a greater balance between growth and free cash flow after the initial stages of product-market adjustment are established.
Related: How to Stay Profitable in a Changing Market?
Prioritize what’s important
For small business owners and startup founders who have worried less about generating free cash flow and want to strengthen their balance sheets, there are a few things you can and should do immediately.
First, you need to determine the math that will help you control your combustion. You and your team need to find a realistic revenue trajectory and break-even point. Without realistic expectations for your short- and long-term revenues and fixed costs, you and your team can never plan for responsible, realistic and profitable growth.
Once you have your earnings and the break even point, you should be able to figure out what you plan to spend. Armed with that spending figure, it’s time for leadership at all levels to look at how their operations relate to revenue. This is where you need full support from your team and probably a significant change of mindset.
People get sloppy in good times, which we’ve all enjoyed over the past ten years. There’s more room for experimentation when the horizon is far away, but with the horizon getting shorter, pies getting smaller and forecasts getting less sunny, business leaders must become relentless in prioritizing projects that generate revenue – everything else has to become a luxury seen. Projects outside of the revenue streams will likely either have to operate on a slimmed-down budget and with more creativity or stay on the shelf until the sunnier days come.
Being honest will be important here. Be honest with yourself as a business leader about your growth and spending trajectories, with your team about what can and will be prioritized, and with investors about what you are doing to generate cash flow. Setting these expectations is essential to keep your employees motivated and engaged during what can be a stressful time.
Related: Positive Cash Flow and Smart Financing Solutions
Focus on productivity
As I’ve seen various economic cycles come and go, there are always two terms that seem to come back with a vengeance in every downturn: efficiency and productivity. While there is nothing wrong with running an efficient business, it seems to me that many companies and leaders only prioritize efficiency in difficult times.
Instead, I wish leaders focused more on productivity. For many, it will be a throwback to the early start-up days when teams were lean and sloppy. It’s amazing what teams can do when they’re focused on making the biggest impact at the highest priority work. Keep your teams focused and aligned on the right things, and eliminate the low priority items. You will be amazed at what can be achieved.
There’s nothing wrong with making operations more efficient, but this can’t and shouldn’t be a short-term solution that goes out the window once things look better, nor is a focus on productivity. If and when we climb out of inflationary and recessionary periods and your team again prioritizes growth over cash flow, you’ll likely be in a similar situation the next time markets start to decline.
Related: Why Founders Should Focus on Productivity Instead of Efficiency
It is easier to burn cash than it is to generate positive free cash flow. That is, it’s easier to put off hard decisions rather than making them now. If the past few years have taught us anything, it’s that the future is unpredictable, and businesses — especially SMBs and startups — would be wise to create a safety net built on a foundation of profitability. Be realistic with your revenue and spending expectations and prioritize projects that offer the best opportunities to drive growth and efficiency. This enables long-term sustainability in good and bad times.