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How Businesses Fail: A story of cash runway

Consider the following: an unprofitable company that survives for long periods of time without ever breaking even, and a profitable company that suddenly closes its doors.

What do these two businesses not have in common: Cash Flow.


How does cash flow give some ventures the ability to survive into zombie-like states whereas cash flow can kill even the most profitable ventures? It’s all about the long-term flow of cash. If a business has a neutral cash flow it is spending its cash as fast it is received, for example if a company has weekly total expenses of $20,000 and weekly total revenue of $20,000 the cash-in will equal the cash-out. This puts the business in a precarious position, if the weekly outflows increase, there is a loss of a major customer, an increase in bad debts, fines, increases in interest rates, raising costs, or a million other things… it can mean that the cash outflows become larger than the inflows on a weekly basis. If the trend continues for a prolonged period of time it will drain the business’ bank account until there is no cash left and not enough in future cash flows to continue to float the business. In this example the business closes its doors. The above reasons for downturns in revenue or increases in expenses can happen at any time, to any business, so what made the example company go under? In normal conditions, a change in weekly cash flow should not derail or shutter a business so there has to be an underlying root cause for the business to close.


It could have been a bad business, have bad management, or a bad balance sheet. If it was a bad business that means that the example company had no fundamental competitive advantages. Businesses that will endure have some trait that allows them to operate better or operate cheaper than their competition. If a business is bad it has no intrinsic defensibilities, or moats. Brick-and-mortar retail often comes to mind, sure it can be made efficient and optimized, but it is being slowly eaten away by e-commerce. Brick-and-mortar only has a moat if they sell products that cannot be sold through e-commerce, like cannabis. However, that moat can be eroded by more brick-and-mortar competition in a given market. So dispensaries have to operate cheaper or operate better than their competition.


What if the business has bad management? What is bad management? It could be poor decision making in strategy selection, or poor in execution of that strategy, or a combination of both. Some management can be good in execution but choose the wrong strategy, this management will fail to capitalize on the business’ advantages or they won’t find ways to develop new advantages. With a good balance sheet, even at neutral cash flow, this type of management can operate for a considerable time before the market turns against them. Poor execution of strategy is much more easily apparent and takes much less time to show its cracks.


That leads us to the third and final root cause of a failed business, a bad balance sheet. If a business has a high debt to income ratio they will be negatively impacted by increases in interest rates, hurting their overall cash flow. Businesses with bad balance sheets will get flushed out of the market by the economic cycle, this is what is coming to the cannabis market.


Credit cycle changes and the bad balance sheet


If a business has debt and that debt is due, then the business will attempt to refinance and possibly restructure the debt. There is no denying that cannabis businesses face higher interest rates on debt than most non-cannabis businesses, so refinancing will only get more expensive as interest rates are at current levels because of the risk premium that will get added for being in the cannabis industry. If these businesses by and large are more susceptible to interest rate increases and face a lack of available lending sources, they must be more cautious than any other business about changes in cash flow. For these businesses, one bad quarter can end the company.

There is a looming credit cycle crash on the horizon for Colorado Cannabis, with the market continuing to shrink, and the cannabis industry as a whole being about 1.5 months delinquent on payments. Total revenue is shrinking, and delinquencies are increasing; this will flush many bad businesses out of the market, but it will also harm good businesses.


Now is the time to prepare: to strengthen balance sheets, increase the frequency of collecting on receivables, reducing costs, and adjusting rolling 13-week cash flow projections. Prioritize positive cash flow and increase cash reserves. We are available to talk with you about making these changes in your business today.


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