As listed market investors, we tend to think about and write about capital allocation (by ourselves and by our investee companies) for much of our time. Outstanding books have written on the subject such as ‘The Outsiders’ by William Thorndike Jr. What this Andreesen Horowitz piece does is highlight a specific subset of capital allocation is which is arguably even more important to understand properly i.e. how a company manages its cash. As entrepreneurs building a business largely with our own savings, we have had to think very carefully about cash management over the past four years. Hence we found three specific messages of this well written piece to be particularly useful.

Firstly, you cannot run a company without being on top of your cash in bank and your free cashflow (i.e. cash coming in less cash going out of the firm) all the time: “Cash management should be a top priority for CEOs. To stay alive, right now more than ever, companies should know: 1) how much liquid cash they have at any given point, and 2) realistically how many months of runway they have. With a strong command of the timing of cash needs and active runway management, a company can save itself a lot of time and heartache around a painful cash crunch or — worse — death.”

Secondly, profitability matters far less than cashflows. Revenues matter even less than profitability. Fantasy metrics like GMV shouldn’t even be part of the discussion. Cashflow and cashflow alone is the critical metric to understand the health of a business: “There are generally two ways to track your accounting records: cash basis and accrual basis. While accrual accounting is important for recognizing costs and revenues when earned and is the basis of GAAP accounting and reporting, it can be less useful for tracking your anticipated cash flow as a founder. Cash basis accounting recognizes actual cash payments and collections, regardless of when earned or incurred. To help think about your cash sources and uses, it can be helpful to think about it in terms of operating, financing, and investing cash flow.

As a startup, you have cash sources and uses from operating — revenue from your customers, salary expenses, marketing spend, etc. — depending on stage. There’s also financing cash flow, which for a startup is cash you’ve typically received from your debt or equity raises…The technical accounting definitions are less important here, but the principle behind the distinction does matter. Your startup’s cash needs must be financed by some combination of cash generated by the business, if any, and how much cash you’ve raised. Managing this cash flow in and out is cash management.

A common mistake that startups make when figuring out their cash position is counting all of their earned revenue against their expenses (i.e., some form of accrual accounting). This brings us back to the point that timing matters. Cash that you have not received is not cash. Realistically, customers are going to pay you late, and some are not going to pay you at all. You need to account for this when you think about how much cash you need. Accounts receivable (i.e., the money that your customers owe you) is not actually cash because you haven’t received anything that you could use to pay your employees or make your interest payments. Until you receive the cash payment, it is not cash.”

Thirdly, when it comes to looking after your surplus cash, what matters most is preservation of capital and NOT return on capital: “Now that you know how to calculate your liquid cash position, you need to develop a plan to manage your runway and understand how many months your cash will keep you afloat. The key, timing-based cash principle here is understanding the difference between operating cash and strategic cash. Everything you need to run your business for the next 12 months is your operating cash; this includes salaries, rent, and interest payments…

Once you have a sense of your forecasted cash needs, you can determine where to leave the cash, according to the required liquidity timing. Operating cash can be put into a deposit account that you can pull from whenever you need it. For strategic cash, since you don’t need it in the short term, you can consider investing in a yielding account like a money market fund. These accounts can be less liquid. Distinguishing between these two types is critical; if you know you’ll need cash to make short-term payments, for example, do not tie it up in something long-term.

In today’s rate environment, fortunately, you can comfortably earn 2-3% in a highly liquid low-risk sweep account or money market account….Remember that when it comes to investing your cash, your first goal is the preservation of capital, and second to that is liquidity. You need to make sure you can cover all of your near-term operating expenses — even in your worst-case scenario — as well as any one-time payments before you look for yield. Be conservative and remember that maturity matters!”

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Note: the above material is neither investment research, nor financial advice. Marcellus does not seek payment for or business from this publication in any shape or form. Marcellus Investment Managers is regulated by the Securities and Exchange Board of India as a provider of Portfolio Management Services. Marcellus Investment Managers is also regulated in the United States as an Investment Advisor.

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