Whether you’re starting up or growing, cash is always king - Sunday Times

Businesses go through distinct phases and revenue can be ‘vanity’ if the cost of generating those sales is too high. You need money in reserve, especially if things go wrong

Although I’m frequently bowled over by the entrepreneurs I meet, I sometimes wonder if they always know what I mean when it comes to, “Revenue is vanity, profit is sanity, cash is reality.” Sometimes they can be focused on the wrong one and don’t necessarily understand the implications of each.

Success depends on knowing what matters at each point in the four phases of the life of a business: starting up and proving the model; team expansion and growth; expanding abroad; and finally evolution — or death. Whether you should concentrate on revenue, profit or cash depends on which bit of that cycle you’re in.

For instance, in the earliest stage, your core ambition must be to prove the business model, copying and pivoting as needs arise. There’s little benefit in growing revenue massively at this point; size is less important than getting things right and minimising costs. Cash is what you need — your cash, rather than anyone else’s, which will dilute your shareholding. I’ve never been a fan of the bottomless pits of cash that so many dotcoms consume without proving their business model. Keep costs tight and make things work first.

Seek external support once the model is proven. Here’s when you need investment to scale up, build a stronger infrastructure and hire a great management team and support staff. It takes time to get these pieces in place, and the longer you delay securing that investment, the more you’ll be playing catch-up.

This is when revenue takes precedence because you now need to prove the scalability of the business.

Then you’re in the third phase, when it’s about showing you’ve got a business that can provide a healthy profit margin on sales and a significant return on your capital. And it’s when you start to think about adding an international dimension to your model and making it “omnichannel” — which could be taking it online or into bricks and mortar.

Match the financial responsibilities to these phases and you’ll avoid the error I made when growing HomeServe. Back then, I mistakenly thought that if I grew revenue fast, I would get significant economies of scale, which would lead to profitability. It didn’t, and it won’t. For companies that haven’t yet proven their business model, this kind of strategy will increase their losses, no matter how effectively they scale up. I look back at my experience of this as one of my most important lessons in business. Instead of getting economies of scale as my emergency plumbing business grew, the break-even line got further away and monthly losses increased from £10,000 to £50,000 a month.

Cash remains king in all these cycles. Make sure it’s coming in and you’ll know how the business is performing. And when it’s that growth-focused second phase, cash from an investor, or debt, can help you make investments in the right people. Having plenty in the bank might not be your business purpose, but it enables you to grow faster and with greater certainty. High revenue from sales might look impressive but, in my experience, regular inflow of cash is much more important.

That’s also because, at some point in the development of a business, something will go wrong. Create a dashboard of management information that shows you the health of your cash reserves alongside revenue and profit. Look at cash weekly, and look at revenue and profit monthly. By doing so, you can avert any crisis.

Cazoo is a perfect example of a company that didn’t pay enough attention to those four phases, preferring to grow internationally too early; the online used-car business expanded across Europe without ensuring that its model worked sufficiently well in the UK. When it listed as a special-purpose acquisition company (Spac) in New York in 2021 — three years after forming — it was valued at $8 billion. But it failed to get beyond the first phase of proving the business model. Annual losses far exceeded £500 million and it went into administration earlier this year.

Contrast that with sports goods company Gymshark, which attained the “unicorn” status of a $1 billion valuation because founder Ben Francis stayed focused and understood the importance of the different business phases. First, he tested and learnt like an entrepreneur — pivoting from fitness supplements to designing and selling fitted, lightweight, physique-enhancing gymwear online. Next, he made Gymshark more professional, with a management structure that included bringing in former Reebok executive Steve Hewitt, first as an adviser and then as chief financial officer.

I wasn’t always so disciplined. At HomeServe, I had itchy feet, wanting to open in more territories and expand the product range. If I had been committed to doing less but better, we would have been a bigger business and grown faster, benefiting from a higher net profit margin. So it’s always a good idea to have a chief financial officer strong enough to keep everyone disciplined, challenge new ideas and investments, and stay focused on the core business.

That’s why Checkatrade, a business I have invested in, operates only in the UK, in the same way that companies such as Auto Trader and Rightmove do.

Revenue is not always the sharpest tool when measuring the health of your business. It’s thought of as “vanity” because it doesn’t take into account the cost of generating that revenue. Growing customers and sales is vital, but at what cost?

Profit can also be misleading. It’s certainly a better measurement than revenue of how well your business is performing in phases two to four. But it won’t always pay the bills. You can be profitable but run out of cash if your customers take too long to pay you, or you go bust because you haven’t evolved. BlackBerry and Blockbuster are classic examples, Mothercare a more recent one.

That’s why cash is king.

Richard Harpin is founder and chairman of HomeServe and growth partner and owner of Business Leader magazine