Skip to the content

Turnover's Vanity - A Guide To Funding Losses

“Turnover’s vanity, profitability is sanity, but cashflow’s reality”.  Told to me by a former mentor, and words I still think about for my clients - and in my own business.

Company’s do not go out of business because they are making losses, they go out of business because they run out of money and do not have the cash to pay their bills.

The balance sheet is a simple tool to understand this, you have assets and liabilities, and at the end of the day, the balance sheet must balance!  And everything else moves together, like pulling levers… all other line items staying the same, if one asset increases then the other asset decreases. 

But if looking at an asset and a liability, if the asset increases then the liability increases too, and vice versa.  So, items in the same category (assets or liabilities) are like a seesaw, one goes up and the other goes down; while those in the opposite categories are like people in an elevator, they both go up or down together.

So why don’t losses result in company’s going bankrupt?

Don’t misunderstand me, I am not saying that losses are always ok, they are certainly a contributing factor to a company’s demise.  But they are not the complete reason. 

Loss making can also be a strategy – we hear of many companies, who are running at a loss each year but are creating value.  Think of an internet startup, or a new invention or drug, they may not have any sales for years but have to pay for their staff, and rent, and other costs – losing money each month. 

But they use the balance sheet to be able to fund their losses, and create value through bringing the drug or invention to market, or by growing their customers until they are profitable, or by becoming valuable to another company to purchase, such as having millions of users or an attractive technology.

So, if your business is making losses, how do you stay in business.  Well, it’s all about…

…Balancing that Balance Sheet

But where to start?  I like to look at the movement in the retained profit, which is essentially your profit or loss for that period, so it shows me how much the burn is.  If you are a startup burning cash each month (losses), then the losses will result in either your assets going down or your liabilities going up.

Assets going down could mean your bank balance decreasing or going into overdraft, but if you don’t have an overdraft from the bank or funds to cover it, then it could be a decrease in your receivables - people pay you quicker. 

Or a decrease in inventory, because you were able to sell something already purchased or made. 

Or a decrease in fixed assets, because you sold your car or computer or truck. 

But these are short term solutions; you don’t have lots of trucks to sell, and can’t keep getting your customers to pay quicker, if you have any.  So, your liabilities will generally increase.

The Good, The Bad And The Ugly (Increases)

Now, strategically, we want good increases.  Good increases are planned and agreed increases in liabilities.  Examples would be getting a bank loan, taking out a credit card, or lending money yourself to the company. 

These are agreed with the lender first, and you will have to have the ability to repay on the terms of the loan.  Short-term ‘good increases’ could also be agreeing with your vendors to increase the number of days they give you credit for, and essentially, they are helping to fund your business; or factoring your invoices. 

However, it’s an agreed increase in creditor terms or factoring, and is a one-off benefit for the month you move from shorter credit to longer.  Or if you are a growing business, you will get one big benefit and then smaller increases as your trade creditors or factoring increase with growth.

Bad increases would be not paying your staff, stretching your suppliers (without agreement), or not repaying loans on time – technically, the last is not an increase in a liability, but it’s one staying the same that should’ve gone down.

And ugly increases?  Well, they’re just bad increases that have gone on for a long time, and without communication from you, with your phone off and your email silent, an ostrich with its head in the sand, hoping things will get better or go away. 

Ugly increases are the ones that hamper your business, and will kill it – eventually your staff will leave, and your creditors will put your deliveries on hold, cut off your electricity, change the locks on your office, or call in their bank loan.

And Then, Of Course, There’s Equity

Although it’s below the line on the balance sheet, I like to think of it as a liability: firstly, because it’s a credit balance; and secondly, because you’re ‘giving something away’ – it has to be repaid, not like a loan, but when you sell the company or issue dividends, you’re effectively paying back the equity investor

A lot of technology or drug companies use this strategy, with various rounds of raising money; hoping that with new advances or growth, the value of the company will increase, and each round will therefore be at a higher valuation, so they can raise more money by giving less percentage away.

To Fail To Prepare, Is To Prepare To Fail

So, if you are going to run at a loss, first try to make sure it’s predicted and not a surprise, so that you can plan ahead.  For short term losses, you can fund by some temporary measures, like an overdraft or short-term loan, credit card, selling an asset, or agreeing an extension of terms with creditors.  Strategic long-term losses are usually funded by loans or equity.

And remember to keep talking to your liabilities – people worry when they don’t hear from you, but if you communicate and are honest, and they see an end to the problems, then they may just work with you to keep the lights on.

And, of course, profitability always helps the balance sheet!


Please Share

If you have found the information in this post helpful and have learned at least one thing, then please share it with your friends and colleagues so they can have a read too.

About the author

Gordon Livingstone

Gordon Livingstone

Gordon specialises in assisting start-ups and high growth companies.  He also helps UK companies who wish to expand into the US, and vice versa.

He qualified as a chartered accountant and holds an MBA from Babson College in Massachusetts - the #1
global school for entrepreneurship.

Get Results In 90 Days Or Less

Are you frustrated with nothing happening quickly? Are you getting pressure to achieve results? Yes.

We understand your pain points, so let us help you get results in 90 days or less.