The sad truth is that cash flow surprises can kill many startups, even though they should have been funded adequately enough to survive. Overall, poor cash flow cause 90% of small business failures, according to the D&B Small Business website. Cash is king when it comes to the financial management of a growing company, so this is not the place for shortcuts and sloppy practices.
Good cash flow management, in simple terms, means understanding every inflow and outflow of cash and never delegating this task. In principle, you must delay every outlay of cash as long as possible, while encouraging everyone who owes you money to pay it as quickly as possible. Surprises are unanticipated lags between these two events as well as unplanned cash outlays.
I will outline here ten key principles and disciplines that every entrepreneur must understand and practice to minimize surprises and failures in this area:
- Failure to document cash flow projections is a disaster. No matter how small your company is today, there are more moving financial parts than you can’t manage dynamically in your head. Of course, you can’t predict everything, but writing down what you know will identify existing problems sooner, and allow other team members to help.
- You can be on budget and still run out of cash. In the real world, spending happens fast and money coming in happens slowly. Thus your monthly budget may balance, but if planned income comes later than planned expenses, you have a short-term cash flow surprise shortage and neither banks nor investors will help you on this one.
- Your startup may be profitable, but broke. Profits don’t necessarily translate into cash. You can make profits without making any money, since the first priority of most startups is to reinvest everything back into the business for growth. There are a lot of accounting tricks to make your business profitable, but it takes real cash to pay the bills.
- Seasonal sales fluctuations eat cash. Fluctuating sales means more inventory is required to cover the ups and downs. Every dollar in inventory is a dollar less in cash available, maybe even two dollars less if your gross margin is 50%. If you try to vary the number of employees to match, that costs even more cash for hiring, firing, and layoffs.
- Unanticipated expenses and emergencies drain cash. The chance of unanticipated expenses, in my experience, is close to 100%. It could be a natural disaster, much like a flood or windstorm, or it could be a loss of key personnel, equipment failure or a major customer complaint on the Internet. Every startup has an unplanned pivot and they all drain cash.
- New businesses don’t get “normal” terms. It’s easy to forget that your new office rent asks for first, last, and security; new utilities require an escrow account; and new vendors want immediate payment for the first couple of months before they offer the normal net 30 terms. In addition, your new customers expect a free trial period.
- Sales volumes are still ramping up while marketing expenses are at max. In the early days of a new business and every time you make changes, sales volumes slip just when you need them most to cover the extra marketing expenses and new infrastructure. Your old “cash cows” are dying, while the new ones are still fed heavily.
- Even good customers don’t always pay on time. The Kauffman Foundation reports that late payments are among the biggest challenges facing startups. According to the Receivables Exchange, small businesses now wait nearly 50 days on average to receive payment. If you are dealing with distributors, that wait can easily be four or five months.
- Higher than anticipated growth has put you in cash flow hell. The faster you grow, the more cash you need to build product, facilities, staff and service. These are “up front” costs that can’t wait the four or five months before the sales and revenue catch up. If you can’t deliver to match the growth, your house of cards comes tumbling down.
10. Bankers and investors hate negative surprises. If your execution doesn’t include the expected cash flow management, investments can be withheld and executives lose their jobs. I recommend that you buffer your initial requests for funding by 25% and then add a line of credit to cover contingencies and minimize the chance for negative surprises.
On top of that, there are the founders that overreact. They pay just the smallest bills and let the rest slide, or they stretch out all payments until vendors complain, reduce your discount or eliminate your credit. If payroll is late, morale and confidence go down, the good people leave and your startup spirals into the ground. For all these reasons, it’s worth your focus to prevent cash flow surprises.
Image credit: CC by Pip R. Lagenta