Most startups don’t have millions of dollars in funding to keep their operations afloat.
Surveys conducted by Wells Fargo Small Business Index in 2006 and Kauffman Firm Survey between 2004-2008 showed that most startups have anywhere between $10,000 to $80,000 as capital in the first year.
Thus, it is essential that in order to survive and grow, the cash flow has to be strategically optimized at all times. Poor cash flow management or a failure to account for early cash flow issues have long-term ramifications on the viability of the venture.
The Problem With Poor Cash Flow
You don’t have to dig deep to find the brutal truth: 9 out of 10 startups fail within the first few years. However, it isn’t always clear as to why these startups flop.
U.S. Bank’s recent survey to answer this question revealed that 82 percent of the time, it is poor cash flow management and/or a poor understanding of cash flow that contributed to the failure of a small business. In other words, almost every business that shuts shop does so as a direct result of poor money management. And when you think about it, this makes a lot of sense.
During the early stages of growth, expenses are almost always going to be higher than revenue. As you attempt to validate R&D, ramp up marketing efforts, figure out pricing, develop sales strategies, and build contractor relationships, it’s going to feel as if you’re bleeding money – and you probably are. But you still need a plan – otherwise, your cash tank will be empty even before you get a chance to hit the gas pedal and accelerate growth.
4 Tips for Fighting Through Cash Flow Problems
While the numbers may seem dismal, you can make it successful as a startup if you take care of certain aspects of your cash flow. Studying the successful ones, some useful trends emerge.
Here are a few of the top ways you can learn from these businesses and fight through and overcome early cash flow struggles:
- Get Payments Up Front
One of the biggest mistakes startups make is getting a commitment from clients without any money exchanging hands. This can really put a strain on your cash flow and create accounting headaches down the road.
“If you want to protect cash flow, make sure that your terms include payment prior to shipment or work from a retainer or pay-in-advance structure where customers hand you the money before your startup puts in the work,” business consultant JT Ripton writes. “This turns a cash flow crunch into a cash flow surplus because you get paid prior to rendering your services.”
While it sounds simple in theory, it isn’t always easy to convince a new client to hand over money to a startup that has yet to prove itself. As a compromise, you may be able to set up a payment structure where you receive different percentages of the payout as checkpoints are reached.
- Manage Fixed vs. Variable Expenses
Every startup needs to know what its burn rate is – i.e. the measure of negative cash flow that describes the rate at which you can spend money to finance overhead before you start to generate positive cash flow (or go out of business).
When calculating your burn, divide it into two subparts: fixed and variable.
Fixed expenses are those incurred on a monthly basis for inventories and logistics such as rent, salaries, equipment costs etc..
Variable expenses are related to transactional volume. This includes expenses like direct materials, production supplies, hourly wages, commissions, credit card transaction fees, and shipping expenses. These can be scaled up and down according to activity.
The latter is much more controllable.
“Try to keep fixed expenses at a minimum, and make them as variable as possible,” myStartupCFO suggests. “For example, link a percentage of your sales team’s salary to a bonus linked to the business they bring in or sign a lease agreement that gives you the right to expand your office at the same location but doesn’t weigh you down if you don’t need the space right now. This will help you control the burn if business dips tomorrow.”
- Avoid Adding to Payroll
One of the bigger mistakes startups make is increasing their employee strength, beyond their needs, too early in the process. While it’s helpful to have a team of people working for you, salaries limit cash flow. Resist adding to the payroll for as long as you can.
With that being said, you need talented people, particularly in sales. If you have good salespeople on your team, don’t cut them just yet. Instead, you may think about cutting your worst clients. As the Pareto principle says, 20 percent of your clients create 80 percent of your stress and problems. It’s counterintuitive, but it will allow you to reallocate your energy and resources to more profitable customers.
- Add a Bookkeeper or an Accountant to your team
While it is important not to burden your payroll, it is vital to hire a bookkeeper or accountant to your startup. When cash flow is vital to the survival of your startup, you need to ensure it is in the safe hands of a finance professional. An accountant takes care of your checks and balances, ensures correct tax filings, and keeps a vigilant eye on the cash flow. You, as the founder or CEO, can run the administrative and product part of the company, let the accountant or CFO handle the finance part of it. This will go a long way in ensuring that you are not one of those startups who fail in the initial few years due to cash crunch issues.
Weather the Storm
It’s easy to become overwhelmed by all of the challenges your startup faces in the early stages of growth and development, especially when you face a cash crunch.
But the successful ones do not quit. They instead take proactive steps to set up a workable solution which paves the way for future success. Following some or all of the steps highlighted in this article, can help you navigate and rise above your cash flow challenges.
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