You already know that you’re going against the odds by running a startup; only 20 percent of new businesses survive past their first year of operation, according to the U.S Bureau of Labor Statistics.
What you may not realize is that many of these businesses fail because of cash flow problems. Not failure to have a great product. Not staffing the right talent. Not the competition. Businesses fail because cash flow becomes a problem and that hinders a startup’s ability to grow, compete and take it to the next level.
So let’s talk about cash flow for a minute here. Whether your business is humming along or you’ve already got trouble with cash flow, it is important to stay on the right side of the cash flow issue at all times.
Here’s how you do it.
Get Payment Up Front
One mistake that startups often make in the rush to get clients and generate revenue is taking on work before payment comes in.
Even if you have committed clients or customers and a clear paper trail of products sold and services rendered, collecting payment after work has been performed creates an ongoing collections headache and often leads to a cash crunch. You may have revenue booked, but that doesn’t help you maintain the needed operating capital.
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. This turns a cash flow crunch into a cash flow surplus because you get paid prior to rendering your services.
Sync Your Credit Terms
A second way to keep your cash flow from becoming a problem is by making sure that your invoicing is in tune with your payments to suppliers and contractors.
For instance, you might give customers 30 days to pay for your services, but the contractors serving your business work from a retainer structure that requires payment a month in advance. With the typical startup having income cycling up and down over the course of several months, having credit terms out of sync can quickly create a cash flow issue.
“If the credit terms you have set your customers are out of sync with the credit terms set by your suppliers, negative cash flow can build up and worsen over time,” notes a recent Growth Capital Solutions blog post on the topic.
Talk with your suppliers and contractors about payment that is inline with your billing practices to avoid this crunch, or consider adjusting your payment terms to your expenses if that’s not possible.
Practice Better Invoicing
Equally or more important than syncing credit terms is actually issuing invoices reliably to customers. Booking revenue is great, but startups often get in trouble when they take this booked revenue for granted and don’t issue timely invoices for payment.
Make sure you have a system in place to automatically invoice and track payment, and make sure you add urgency to these invoices.
“When you delay invoicing, it’s easier for the client to also delay their payment,” notes a blog post by free invoicing solution, Invoice Ninja.
“This is not necessarily malicious on their part,” notes the company. “It’s just that business owners and employees are busy and might see your late invoice as something to complete later rather than sooner, due to your own lack of urgency.”
Watch Your Gross Margins
Your sales might be solid, but you still can have cash flow issues if you don’t have large enough gross margins around your product or service. Are your margins really enough to support the operating capital to run your business?
“Small businesses sometimes sell their products and services for such low prices that they have low, or negative, gross margins,” notes a recent blog post by Commercial Capital. “This scenario often happens in highly competitive environments with constant pricing pressure. It usually affects small business owners who do not have a clear understanding of their costs.”
What you need to watch is calculate the all-inclusive cost of your product or service to make sure that you actually have healthy enough margins to keep the business running. Many startups set a price and get surprised when they discover that their back-of-envelope calculation on margins is not actually correct in practice.
If this is the case for your startup, reevaluate your proposal pricing or consider cost-cutting or raising prices to avoid a cash flow issue.
Cut Down on Overhead Expenses
Finally, mind your operating expenses.
As a startup, you undoubtedly are already familiar with the growth strategy for making a business profitable. Don’t forget the other side of the coin, however: you can make a business successful not only by expansion of market share but also by cutting costs. Efficiency with overhead expenses is a dark art that not only helps with profits, but also with cash flow.
Learn this art of cost-cutting when it comes to overhead. If costs are low, your business can maintain a positive cash flow even when sales are down.
The trick is separating expenses that are absolutely necessary for your product or service from those that are theoretically necessary for your company but might not actually be that important. This includes online services that aren’t strictly necessary, communications platforms that overkill, and things like travel expenses that aren’t strictly necessary.
Until your business has truly made it off the ground and cash flow is healthy, get stingy with these overhead expenses that may be nice but not strictly necessary. They can sap your cash flow quietly if not watched closely.
Don’t let your startup be part of the business failure statistics. Mind your cash flow.