Looking at successful startups, you might assume they've had their ducks in a row from the very beginning. That isn’t always the case.
When you’re low on cash, it’s hard to imagine that anyone has ever been where you are now. But most small, growing businesses need help managing their cash flow.
Unfortunately, many underestimate just how essential cash flow is and fail to take the necessary steps to secure a healthy financial future.
How can poor cash management affect a startup's success? Delayed payments, inability to invest in growth opportunities and difficulty meeting financial obligations are just a few obstacles that poor management can create.
This article will provide an overview of what cash flow is, how startups should manage cash flow, and how to navigate periods of low cash.
What Is Cash Flow?
You can have:
- Positive cash flow: You have the money to make investments or pay back debts, potentially leading to higher profits.
- Negative cash flow: It’s difficult to cover essential costs. You find yourself delaying payments or spending more money than you bring in.
Cash flow is essential for any business, but it's particularly important for startups. Unfortunately, startups often don't have the capital or resources to withstand any dips in income, so a reliable flow of cash helps pay bills and give your room to make investments towards growth.
It’s important to remember that cash flow and profit are different. Profit is the money that remains after subtracting business costs from your overall sales revenue, while cash flow measures how much available money a business has for use during a set period.
What Is A Good Cash Flow?
Your business's financial health depends on having enough money to cover expenses, remain operational, and pursue opportunities. A healthy cash flow goes beyond bill payments, as unforeseen expenses can arise suddenly.
Companies with sufficient reserves can cover unforeseen expenses without affecting their budget.
For startups, growth is often the main focus. However, rapid expansion can harm your future. Taking on loans or debt to fund expansion may lead to spending money that hasn't arrived yet.
Startups that balance growth and maintain cash reserves demonstrate financial control and attract investors.
With the right cash flow management strategies, you enhance your competitiveness and enable the achievement of long-term goals.
Types Of Cash Flow
There are three main types of cash flow:
1. Operating cash flow
The money generated from your startup’s day-to-day operations. This includes any customer payments, sales, interest earned on investments, and other sources of income.
Operating cash flow formula: Operating cash flow = sales revenue – operational expenses
2. Investing cash flow
The money you receive from investments or spend on acquisitions. Money from selling stocks, bonds, or real estate and any money spent purchasing these items belong here.
3. Financing cash flow
Money you get from taking out loans or issuing equity. Cash from taking out a loan, issuing stock or bonds, and other forms of financing fall under this category.
You can utilize all three types of cash flow to fund your startup's operations. Awareness of each type and how it affects the financial health of your business will help you make better decisions to maintain positive cash balances.
Cash Flow Formulas
There are three key formulas that startups need to know: net cash flow (NCF), free cash flow (FCF), and unlevered free cash flow (UFCF). These formulas will help you analyze and understand the ups and downs of your business.
1. Net cash flow formula
Determines the total amount of money coming into and out of a business over a given period. You can calculate it by adding all cash inflows (revenue, interest, investments) and subtracting all cash outflows (expenses, debt payments).
Net cash flow = total inflows – total outflows
2. Free cash flow formula
Determines how much money a business has available for use. You can calculate it by subtracting capital expenditures from operating capital.
Free cash flow = operating capital – capital expenditures
3. Unlevered free cash flow formula
Determines how much money a business has to invest and cover other expenses without considering debt.
Unlevered free cash flow = net income + depreciation/amortization – working capital – capital expenditures
Factors Affecting The Flow Of Funds
Managing your cash and where it’s going isn’t always a straight path, especially if you have plans to grow. Your business will always be changing, as will the factors affecting your finances.
Here are a few to look out for.
1. Sales and revenue
Sales and revenue are your primary income sources. Tracking the amount you're bringing in regularly will help you identify trends and decide when to adjust your pricing or make other changes to maximize your income.
2. Costs and expenses
Keeping up with the amount you're spending each month can help you spot any unnecessary expenses so you can make adjustments to stay within your budget.
3. Capital investments and financing
Investing in new equipment or taking out a loan can add to your expenses, so it's essential to consider the potential impact of any capital investments or financing before making any decisions.
You should have systems to ensure that you pay bills on time and collect invoices as soon as possible. This will help you maintain a steady flow of revenue.
How To Improve Cash Flow When You’re Low On Cash
Startups looking to improve cash flow can start with a few simple steps. Below are the main actions you can take.
1. Identifying and reducing expenses
Start by looking at your financial statements to see where you can make cuts. Look at overhead costs, materials and supplies, insurance, and employee expenses.
Consider renegotiating contracts or finding more cost-effective suppliers.
There are ways to reduce these expenses without compromising your products or services.
2. Increasing revenue and sales
Generating revenue should be your top priority when you're running out of money.
Consider launching new products or services, expanding your customer base, or partnering with other businesses.
3. Consider Raising Funds
When your startup is running out of money, raising funds from investors or applying for a loan can be a viable option.
Having a solid business plan and financial projections that can convince potential investors or lenders is crucial.
Hot tip: Investing in a fractional CFO can help you at every stage of the fundraising process!
4. Seek Expert Advice
Running a startup is not always smooth sailing, and sometimes you might need expert advice to get your business back on track.
Seek advice from experienced entrepreneurs, business coaches, or financial advisors who can help you identify the root cause and provide you with possible solutions.
5. Get in touch with current Stakeholders
Regular communication with your stakeholders, such as investors or partners about your business progress and future plans can help build trust and confidence.
Be transparent about your financial situation and discuss your tentative timeline.
6. Negotiating shorter payment periods with clients
If you have to wait a long time for client payments, try negotiating shorter terms.
You may be able to get paid more quickly and improve your cash flow in the process.
Furthering Cash Flow Mastery
Avoid the financial pitfalls many startups run into by mastering your cash flow. Found yourself low on cash? Try out the tips we suggested.
Controlling this aspect of your finances ensures your startup can mitigate risks and capitalize on more opportunities.
While some business owners may be hesitant to get professional help, it's important to remember that having an experienced CPA or part-time CFO can be invaluable in helping startups succeed. They can provide guidance and advice on the best ways to manage cash, maximize profits, and minimize losses.
With the right knowledge, approach, and support, you can use cash flow to your advantage and increase your startup's chances of success.