Cash flow management problems are one of the top start-up killers today. It is often true that the more funding you raise, the more money you waste. Paradoxically, cash flow management problems frequently occur after investors inject a ton of cash into a start-up. Here’s why:
Entrepreneurs tend to be frugal and prudent when cash flow is running tight and monitoring is easy. Bootstrapping also forces us to think hard about their expenditure to make every cent count.
Conversely, after a huge round of funding, we tend to become complacent and have a grossly mistaken delusion that we have made it big and the future is set in stone. IT IS NOT!
So here is our advice and our fellow entrepreneurs’ experience. Some of whom learnt these cash flow management lessons the hard way so that you don’t have to repeat them. Let’s dive in.
It is true that we should not get too caught up with micromanaging our petty cash so that we can focus on the goals that matter. However, you need your team to buy-in to the reality that a start-up has less resources than an MNC. Every cent counts. With a frugal mindset, your team should ask themselves the following questions before buying anything:
- Do we really need this?
- Do we already have this or a substitute somewhere in the office?
- Is this this the most cost-effective option available?
Question 3 is crucial. Please understand that “cheap” is not the same as “cost effective”. Buying a cheap printer with expensive ink cartridges and a short lifespan is NOT cost-effective. I recommend that you calculate the lifetime cost of using a product before committing to a purchase. Here is an example:
Assume we will print 1,000 pagesper year
|Printer upfront cost||Printer lifespan||Ink cartridge cost||Number of pages each cartridge can print||Number of cartridges used over printer lifespan||Total Cost over printer lifespan||Total annual cost|
|Printer A||$80||2 years||$40||80||25||$1,080||$540|
|Printer B||$140||5 years||$35||100||50||$1,890||$378|
|Printer C||$260||5 years||$50||200||25||$1,510||$302|
Clearly from the example, Printer C is the most cost-effective solution despite having the highest printer cost. The savings per year is actually $238! So take the effort to calculate the best option for your start-up and stretch your dollar to improve cash flow.
I know that your investors will pressure you to maximise your company growth over revenue. You need to be very weary of that advice. What are your investors motivated by? They want your company to group 400% in valuation so that they can quickly exit within 5 years, sometimes 3 years. Right? The reason for their aggressive growth push is because only 10% of their portfolio start-ups will ever make it big, and they promise their investors that they will produce 20% in annualised returns regardless of your long term cash flow management issues.
Your investors’ motivations will seldom coincide with yours, even if they were former entrepreneurs themselves. So, be wise about how you handle investor-relations. Bear this in mind: Don’t hire hastily. Hire right, not hire fast.
What’s more if you want to scale up, automating processes instead of getting more hires will be a much better long-term solution. So keep your team lean with some of the following tips.
- Automate lead generation with TQ Prospector which enables you to consistently get high quality leads from Google directly
- Automate sales follow-ups and account management with CRM software
- Automate financial accounting and budgeting with accounting software such as Xero which integrates with your bank account and minimises manual transaction logging and checking
Stockpiling inventory because you believe you will increase sales
It is true that producing inventory in bulk will produce some cost savings because economies-of-scale. However, what this means that you are locking up your cash in illiquid assets and not being able to do anything else with it. After all, your inventory has a shelf life with depreciating value over time. They may expire, rust or get damaged.
Furthermore, you are paying for storage. Depending on the nature of your inventory, sterile rooms, dehumidifiers and chillers do not come cheap. Stockpiling of inventory is one of the most expensive mistakes you can make.
It is really not worthwhile to make some small savings in bulk orders and forego all other business opportunities with your cash. Protect your cash flow. Don’t stockpile on hope. Stay realistic.
Paying bills on time
This advice may sound odd at first, after all it’s cash out of the coffers. Shouldn’t we delay payment as long as possible?
While some companies do that, it is ultimately toxic for supplier relationships in the long run and opens up the possibility of being charged interest. Hence, it is always ideal to pay on-time, neither early or late.
Of course, the better your negotiating position, the more you should try to get better terms of payment with an extension of your payment due date.
Offering credit to non-creditworthy clients
Repeat after me: DUE DILIGENCE. Bear in mind that however huge or seemingly successful your clients are, they could be another Enron. Check their cash flow statements and statement of financial position. Ask yourself the following questions:
- Can your client afford to pay you?
- What is their credit rating?
- What is their repayment history?
If you suspect that your client is probably unable to pay you, don’t drag the repayment date. Collect what they can pay and be prepared to record a bad debt expense. It’s painful, but it is better to realise small losses early than to realise huge losses later. Don’t gamble with your cashflow.
In the worst case, you might even wish to reconsider taking on the project in the first place. Yes, it looks good as clocked revenue – but revenue that you can never collect on but have to spend your resources to make the project work? That’s throwing good money after bad…
Neglecting your Accounts Receivable
Don’t be a loan shark, but also don’t be a charity. The longer your accounts receivable ages, the less likely you will get paid. Keep following up with your dues. The cash you don’t get back is business opportunity gone. Accept partial payments. If you don’t mind accepting a small percentage loss of the accounts receivable, you can consider factoring.
Factoring means selling your accounts receivable. You will have to pay a percentage of the accounts receivable called a factoring fee. This means of financing is popular among small businesses and it is one option you can consider to further improve your cash flow cycle.
Have you encountered any of these issues in your business before or have more tips on how to improve cashflow for startups? Let us know in the comments below.
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