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Cash flow or profit making! What should startup entrepreneur worry about?

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Cash flow or profit making! What should startup entrepreneur worry about?
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So you have an idea! Do you have strategies to capitalize on it? Yes, we are talking about startups here. They are fast-paced, small and adaptive, and carry a great deal of risks for the participants. New ideas are conjured every day, but only the best startup entrepreneurs succeed with their ideas.

Being a startup entrepreneur can allow you to make your own set of rules but it comes with its own set of dilemmas. Cash flow management is very critical to the survival of a small business. But many think of the general business axioms of quick scalability and profit maximization as the core objectives.

Although profit-making is essential for survival and long-term sustainability of the business, cash inflows rule out the existence of such a venture.

Dilemma of Profit v/s Cash

Profits do not necessarily gets translated into cash. An entrepreneur 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.

Even when the economy is strong, entrepreneurs may find it challenging to secure cash to cover the startup costs and everyday expenses such as payroll, utilities and rent for office space. Many small business startups fail because of poor cash flow management.

Similar is the chronicle of profitable companies too who go broke sometimes because they had all their money tied up in assets and couldn't pay their expenses. Efficient management of working capital is critical for the business health of all companies.

Tough initial years

For startups, establishing cash flow as quickly as possible is important as it takes time to generate sales and earning usually takes a back seat towards the initial set up years. For many businesses, it can take years to reach a point where sales are high enough to turn a profit without tax loopholes and fancy bookkeeping.

Most of the entrepreneurs then end up pocketing whatever the business earns and reinvest the money back to foster quick growth. It's at this moment that a dilemma arrives; how much of your capital can you reinvest, and how much do you keep away?

Reinvestment challenge

There's a lot to consider before deciding on the reinvestment strategy. Smart reinvesting can grow any business at a fast pace, but a poor decision at the wrong time can hinder the long-term growth. Startup entrepreneurs must have cash flow in hand to cover their current commitments and the commitments they anticipate for the future.

Moreover, reinvesting in the business to improve the infrastructure, streamline services, bolster customer support, increase and refine marketing, can directly benefit the startup. It increases profits and decreases the expenses, potentially giving the entrepreneur more capital to work with.

Cash is king

Cash is definitely the king when it comes to the financial management of a growing company. The time gap between paying the suppliers/employees and learning from customers is the problem. An accurate cash flow projection can alert the entrepreneur against the trouble well before it strikes. This will help them in managing their cash flow as well as their receivables.

The basic idea is to improve the speed with which they would turn the materials and supplies into products, inventory into receivables, and receivables into cash. Even after playing smart and safe, an entrepreneur might foresee a situation where he/she lacks the cash to pay the bills.

This doesn't mean one has failed as a businessperson. It's just that he/she couldn't predict the future perfectly. In an ideal scenario, a startup should have enough cash to sustain for 6 months expenses. It eases the pressure on the entrepreneur and he can focus on the product delivery

The Key& Rule of Double & Half

Forecasting is at most important for better financial control. Ventures must do projections for five years—a monthly forecast for the first two or three years and quarterly or yearly projections for the remaining years. The monthly forecasts act as a budget for general, administrative, and sales expenses and also help to assess the effect of quarterly tax payments on cash flow.

So how do entrepreneurs make sure that they are making the best guess when it comes to predicting their business's financial projections on a yearly basis?  They must put down their expenses first instead of the revenues as they are easier to start with and one has more control over it. 

Moving ahead to forecasting revenues, an entrepreneur must do it with both a conservative view and an aggressive view. After making aggressive revenue forecasts, it's easy to forget about expenses. Hence, entrepreneurs must focus on the key ratios to make sure they get sound projections.

A double and half rule is very important while projecting the financials of any start up. An entrepreneur should project half the revenue as per assumptions and consider double the cost he will incur in first year. There will be many unforeseen expenses and cash outflow which will occur in first 2 years. Therefore, this rule helps an entrepreneur for better planning towards these surprises.

Secret of early profits

Now comes the time to emphasize on profit making. The startups who have managed to keep their model asset-lite are the ones who emerge as profitable in a short span of time compared to other ventures. Considering the e-commerce startups, the first few years for them are considerably tough when it comes to becoming viable as they are burdened with huge marketing cost to attract visitors online.

The conversion of such online visits to sales is a direct function of the market opportunity, the ability of the business to scale & customer acceptance. 

For instance, in India, an online channel for financial services may not able to generate more sales compared to a hybrid model which also taps the offline mode to reach out to almost 80-90 percent of the target audience unaware of making a complete transaction online.

Summary

Once a startup entrepreneur gets his/her company up and running, strategies can be expanded and value adds can be increased at different buying, sales or customer contact points along the way. The key is to test and measure what works and what doesn't, because no strategy works perfectly every time.

Cash flow is the lifeblood of a business and critical to its growth.  Proper planning can help establish better control on cash flows and eventually help the entrepreneurs reap profits.

Edition: December 2016

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