Understanding Cash Flows in a Startup
Cash Flow is one of the most popular terms used in businesses and valuations. If you’ve watched the famous television show Shark Tank, you would know how Kevin ‘O Leary (a.k.a Mr. Wonderful) always invests in a venture with positive cash flow.
What is Cash Flow?
Simply put, It is the amount of cash that is actually flowing in and out of the business.
Why is it so important for a business to generate positive cash flow?
A company’s ability to create value for its shareholders depends on how well they manage their cash and if they can generate positive cash flow.
Cash flow can be segregated into three heads – operating, investing and financing. Free cash flow is the cash left with the firm after accounting for all operational and capital expenses and is a common measure for valuations.
The perils of running out of cash are true for any business, but when it comes to a startup, they may have a really tough time managing cash in the beginning. Most of the startup founders go through this problem because they are inexperienced, and lack an estimate/foreplanning on working capital requirements to scale their operations with time. If they could not obtain funding or do not have access to enough capital to hire an accountant/financial expert, they may have a tough time managing cash flows themselves. Startups that face cash flow problems from the start are least likely to obtain any funding from investors.
Cash Flow problems are one of the major reasons contributing to startup failure. Entrepreneurs come up with brilliant & innovative ideas every year but the few that survive are the ones who were able to manage cash effectively along with the execution of their business plan.
A few tips to remember while managing cash in your startup/business
Prepare a detailed cash flow statement. The cash flow statement is one of the most important financial statements. Profit & Loss statement is a great indicator of whether your firm is running a profit or loss, whereas a cash flow statement will provide a real picture into how much is actually being generated or lost by the firm.
Understand and gain knowledge into the different sales points at which the firm will break even and then start generating profit. This will help you in attaining the goals that you have set for your business.
Maintaining a cash reserve is crucial for a startup. Your business might experience a shortfall at some stage and the cash reserve maintained can help the startup come out of the situation without the fear of resorting to debt or worse, insolvency.
The founder shouldn’t handle the money himself, if possible always hire an accountant or CFO who can handle the cash in a better and professional way and also clear up your time to focus on how to develop the business. Nowadays technology has made it possible to use software to manage your funds , thus reducing cost and freeing up some time.
Receivables management is key to cash management. A firm's receivables policy should not be too stringent as that can lead to losing your customers, but also it should not be too lenient that you have to resort to your reserves to make ends meet. Another way to collect your receivables as early as possible is to offer early payment discounts.
After managing receivables, you need to shift focus to the creditors. Work out deals with suppliers and vendors where you are confident of making the payment within the stipulated time, and try extending the payables period as much as you can.
Identify the pulls and drags on liquidity. Drags delay or reduce cash inflows, or increase borrowing costs. Pulls accelerate cash outflows.
Preparing a forecast model for revenue and expenses is essential. Once you have your forecasts prepared you can identify the unavoidable expenses and the avoidable expenses. Try and minimize expense on the avoidable items.
Hiring employees is always a good way to delegate responsibility and focus on the more essential work but only hire when you absolutely need to. Another important lesson to be learnt here is to look for quality over quantity. A single efficient employee can do much more for you than multiple inefficient employees.
Understand when to undergo or forgo a project. In distressed times it is better to avoid high capital projects even if it would benefit your company. The cash involved will leave you with little or no reserves and that can be a disastrous situation for any startup.
Making use of technology is the essential in today’s world. Technology can offer quick and cost effective solutions to complex problems. Technological advancement of your startup is an eye candy for investors as well.
It’s very important to understand that a business can make profits and still run low on cash. Selling a product is a different concept and receiving money on the sale is what ultimately matters.
Growing a startup into a successful business is the ultimate goal for any founder but, where most founders go wrong is they exceed their expense limits to reach that mark. An intelligent founder will look for ways to achieve that goal at the lowest possible cost even if it slows down the journey.
More than ever, now is the right time to focus on cash flow problems.
The pandemic has taken over the world and has affected business at no matter what stage. The magnitude of the effect will obviously be more on startups and other small scale businesses. In such tough times it’s fair to say that “Cash is King”. Startups that have been able to manage cash more effectively will stand a better chance to survive through the effects of the pandemic.
In the end the important thing to remember is that cash management is vital to the survival of a startup and it’s importance can be clearly noted in such distressed situations. Young and aspiring founders need to keep the cash flow problems in mind while assessing the feasibility of their business.