How not to spend your capital

[Photograph by Steve Buissinne under Creative Commons]

Let me say this straight out. When it comes to building your business, there is an alternative to investor capital.

My brother-in-law quit as CFO of a global shipping company several years back, and started a niche IT company. He and his partner have built their company steadily, with internal cash accruals. They considered external funding but didn't seek it; they just put their savings in and built the company from scratch.

Today, they are an extremely profitable, fast-growing, 250-people-plus company with an intent to grow their revenue by 6x in the next five years. All this without any external funding. 

So yes, you can grow big, and you can grow fast without investor capital. It's not easy, but it's definitely possible.

Raising capital is the obvious and a relevant path to take. But my point is this: scarce capital forces you to think harder about your problems, including potential ones. And solutions come only when you apply yourself a lot more to the problems, at times even to the point of obsessing about your problems.

Scarce capital forces you to think harder about your problems, including potential ones.

You may raise capital for all the right reasons, but it's how you spend it that will determine your business trajectory to a very large extent.

You may raise capital for the right reasons, but it's how you spend it that will determine your business trajectory

Consider these two examples. In Mindworks, when we were expanding our media outsourcing business aggressively in the US market, we decided to set up a US subsidiary. Why? Because our customers were asking this of us: they wanted the works - an onshore set-up with a front-end delivery team, and a US-based staff that would be working with client teams.

Setting up a subsidiary in the US meant our cost of operations would go up significantly, but at that stage we thought it made sense for us to be closer to the customer markets for sales and rapid scale-up. We had a pioneering idea and we were sure that media companies in the US would buy in. More importantly, we had the capital to set up onshore operations. So we went ahead and opened a US subsidiary.

The niche IT company I mentioned earlier tackled their growth challenges differently. When they started growing fast and had to scale up their delivery team rapidly, their problem was costs. Remember, this was a small IT company in India catering to a very specific industry, operating in a fast-growing industry where salary costs have been rising rapidly through the last decade or so.

Linear increase in costs was not an acceptable solution for them. And in my view, because they didn't have the surplus capital, they iterated harder with their cost problems.

They decided to set up a sister company in Malaysia. Salary costs of IT professionals were lower there, and so was the corporate taxation rate. They were able to scale up, with improved margins.

To be sure, in Mindworks, when growth stalled and our funds started depleting, we learnt a few lessons in better cash management.

Initially, a lot of cost reduction happened on account of sales and marketing costs in the US. When our key customers went bankrupt, we had to review our entire market focus. So, cutting on sales costs was the obvious thing to do.

Within three quarters, we were able to reduce our burn from Rs 35 lakh monthly to Rs 5 lakh monthly. And then, over the next six months, we turned cash positive. However, the bigger lessons in cost efficiency were learnt elsewhere, which have since proved crucial in rebuilding our business.

The idea that capital should be made to work harder took root in our company from there on. And this is not the same as being frugal in our spending. Here's how we approach this concept.

When we had to drastically reduce our burn, we couldn't wait to build an elaborate enterprise resource planning (ERP) system to figure where to cut. It had to be done quickly.

Our finance team built a simple Excel sheet which listed key cost items across our operations. The senior team got together in a room and reviewed this cost data. For each line item, we asked ourselves this: what if we didn't have the money to incur this expense?

If nobody came up with an effective defence of keeping that expense, it was struck off. We were able to identify the essential expenses quickly in this manner, and the remaining costs came under tougher scrutiny.

We started on this path because of our precarious situation, but then it's become a habit with us. In our monthly review meeting, before we budget any new expense, we ask ourselves the same question: what would we do if we didn't have the money to take this up?

Before we budget any new expense, we ask ourselves: what would we do if we didn't have the money to take this up?

Each time this question forces us to think that much harder about the options we could take. And we keep getting surprised: what we didn't think possible just last month suddenly becomes feasible when put through this no-money wringer.

The other valuable lesson we have learnt is about how all the little stuff adds up to the bigger result.

Weeding out the non-essential expenses were the low-hanging fruits. Once we were past that, we asked ourselves a different question: how can we now become more cost efficient in whatever we are doing?

We decided to take the same approach: look at each line item, and figure out how to improve the numbers by 10-20 percent. Surprisingly, we couldn't find any. Going over it again and again yielded no new breakthroughs.

And then someone suggested reducing the target and identifying opportunities with 5 percent impact. That was a big list.

Many of these had to do with our receivables. In almost all our projects, we found customer payments were delayed by a few days, or even a couple of weeks. In some other cases, we found our invoicing late by a few days. And when customer remittances came through, our banks were booking the money into our accounts a day or two later.

Each one of these items made a 1-1.5 percent impact in cash in each project, so not a big deal individually. And yet when we tightened our receivables management across projects, our aggregate bottom line improved by almost 5 percent.

The attention to the little stuff is not so much a management process as about a different approach to cash. Over time, through these experiences, we have begun to view capital very differently from when we raised money initially.

Our changed mindset is best encapsulated through a hypothetical exercise we often undertake. Suppose we have to take a big spending decision, say a marketing exercise that will cost Rs 1 crore. We ask the same question: what if we didn’t spend this money, but focused harder on getting additional revenue, say even a small amount of Rs 25 lakh?

We then compare cash impact between the two scenarios. Compared to Scenario 1, in Scenario 2 we are better off by Rs 1.25 crore. Now, this is notional and we probably do need to spend that money on marketing. And yet, this process forces us to re-evaluate our spending decision quite rigorously.

Understanding this dynamics about cash - what is not spent 'increases' cash reserves - can be quite helpful in making better decisions about spending.

Those who come from generations of family business in India know and live this principle instinctively. A lot of first-generation entrepreneurs like me blunder our way to this realization but we need to imbibe this financial ethos.