Case studyLessonAccountingGrowth and business modelsFounders and companies
Growth consumes cash, and a profitable company can still run out
The idea
Nike nearly failed several times while its sales were doubling. Knight's memoir is honest about why: every pair of shoes had to be paid for months before a customer paid for it, so the faster the company grew, the more cash it needed and the less it had. The income statement said the business was profitable; the bank account said it was about to miss payroll. This is working capital, taught as a story. Growth ties cash up in inventory and receivables, and a company can be profitable on paper and insolvent in cash if nobody is funding the gap.
Profit is not cash, and growth widens the gap; model the cash a business needs to grow before admiring its sales.
When it works
Any three-statement question, any growth company's cash flow, and any founder conversation about runway.
When it may fail
Some businesses have negative working capital and grow their cash as they grow, which is why subscription and marketplace models are prized. The lesson is to check which kind you are looking at.
How to use it
Take a company's revenue growth and its days of inventory and receivables, and compute the cash it must find to grow next year. If that exceeds operating cash flow, the growth is being financed, and you should know by whom.
Where it came from
Book Shoe Dog · Phil Knight
What the source says. A memoir that is mostly about working capital: Nike nearly died of its own growth, repeatedly, and the book is honest about why.
Connected ideas
Says something similar
Working capital is where growth eats cash, even when the income statement looks healthyGrowth ties up cash in receivables and inventory, so model the working capital a business needs before trusting its profit.
Worth knowing first
Net income and cash flow diverge by design: revenue is recorded when earned, not when paidAccrual profit is the economics of a period; cash is the bank account. Every difference is a timing gap that the cash flow statement reconciles.
Concepts
Put it to work on L3VLUP
More like this
- FrameworkAccountingDocumentary
An adjusted metric is an argument about what should not count
Judge an adjustment by whether an owner of the whole business would also get to ignore the cost.
From WeWork: Or the Making and Breaking of a $47 Billion Unicorn · 2021
- Company insightGrowth and business modelsLetter located
Forgo the revenue you could capture if the platform grows more by letting others earn it
A platform that lets others earn on it grows faster than one that captures every dollar; the forgone revenue is the investment.
From Shopify's 2015 IPO letter from Tobi Lütke · Tobi Lütke
- Decision principleFounders and companiesLetter located
Given a choice between flattering earnings and future cash flows, take the cash flows
Tell investors in advance that you will optimise long-term cash flows over reported earnings, then do it, so the market can price the choice rather than be surprised by it.
From Amazon's 1997 letter to shareholders · Jeff Bezos
- FrameworkGrowth and business modelsBook
Network effects start in one small market, never across the whole one
Judge a network by whether its first small market is dense and self-sustaining, not by the size of the market it aims at.
From The Cold Start Problem · Andrew Chen