The sad truth is that cash-flow surprises kill many startups. Overall, 90 percent of small-business failures are caused by poor-cash flow, according to Dunn & Bradstreet.
To prevent becoming part of the 90 percent, youâll need to maintain a certain reverence for cash. When it comes to the financial management of a growing company, always remember that cash is king. In other words, this is not the place for shortcuts and sloppy practices.
So what should you do?
Good cash-flow management, in simple terms, means understanding every inflow and outflow of cash, and never delegating this function. In principle, you must delay every outlay of cash as long as possible, while incenting everyone who owes you money to pay it as rapidly as possible. Also, be vigilant about limiting any surprises such as, unanticipated-payment lags and unplanned-cash outlays.
Here, I outline ten key principles and disciplines that every entrepreneur must understand and practice to minimize cash-flow surprises and failures:
1. Not documenting cash-flow projections. No matter how small your company is today, there are more moving financial parts than you can manage dynamically in your head. Of course, you canât predict everything, but writing down what you know will identify existing problems sooner, and allow other team members to help.
2. Being on budget but out of cash. In the real world, spending seems to happen 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. Neither banks nor investors will help you on this one.
3. Being profitable but broke. Profits donât 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 lots of accounting tricks to make you profitable, but it takes real cash to pay the bills.
4. Seasonal sales fluctuations. Fluctuating sales means more inventory is required to cover the ups and downs. Every dollar in inventory is a dollar less in cash available or maybe even two dollars less if your gross margin is 50 percent. If you try to vary the number of employees to match, that costs even more cash for hiring, firing and layoffs.
5. Unanticipated expenses and emergencies. The chance of unanticipated expenses, in my experience, is close to 100 percent. It could be a natural disaster, like a flood or wind storm, or loss of key personnel, equipment failure or a major customer complaint on the internet. Every startup has an unplanned pivot, and these all drain cash.
6. New businesses donât get ânormalâ terms. Itâs easy to forget that your new office asks for first and last monthâs rent, as well as 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. On the other side, your new customers expect a free-trial period.
7. Sales volumes donât always keep up with marketing expenses. 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 âcash cowsâ are dying, while the new ones are still being fed heavily.
8. Even good customers can make a late payment. 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 get paid. If you are dealing with distributors, that wait can easily be four or five months.
9. Higher than anticipated growth. The faster you grow, the more cash you need to build products, facilities, staff and service. These are âup frontâ costs that canât wait the four or five months before the sales and revenue catch up. If you canât deliver to match the growth, your house of cards comes tumbling down.
10. Bankers and investors may withhold funds. If your execution doesnât include the expected cash-flow management, investments can get withheld, and executives lose their jobs. I recommend that you buffer your initial requests for funding by 25 percent, and then add a line of credit, to cover contingencies and minimize the chance for negative surprises.
Then there are the founders who 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 of these reasons, itâs worth your focus to prevent cash-flow surprises.
How do you reduce your exposure to cash crunches? Let us know with a comment.