Managing startup cash flow well is a major factor in the success of any business.
You need cash to pay for your facilities, employees, and suppliers. Without strong, consistent cash flow, at best you will struggle to grow the company. At worst, the company will fail.
Of course, increasing revenue is a good way to boost cash flow. However, this only works if you are able to turn higher sales into more cash in.
In short, more sales does not always equal better cash flow.
Especially in B2B, depending on the industry and the payment terms you can negotiate, it can take weeks (or months!) to get paid.
Since managing cash flow well can be challenging, here are five driving factors to help optimize your startup’s cash flow.
Improving AR isn’t about increasing revenue, but rather collecting what’s due.
For higher sales to affect your cash flow, you’ll need to collect customer payments faster (or at least on time).
Many modern accounting tools allow you to create invoices and process payments automatically.
Of course, the process still requires some manual oversight. But implementing these can help reduce expenses and take some of the labor and manual work from issuing invoices and allocating incoming payments.
Set credit term policies that match the level of risk associated with each customer. For new customers, that could mean requiring at least a partial payment in advance.
Your standard policies should include late fees for past due payments, even for long-standing customers. To show that you’re trying your best to not charge fees, use your invoicing tool to send an automated notice before an invoice goes late.
The more you can automate this administrative side of the business, the easier your life will be. No more manual reminders, no more chasing down customer payments. Spend your team’s effort on more productive endeavors.
Employees are a necessary aspect of many growing startups.
But employees can be expensive. While it’s important to treat employees well, they also need to contribute.
Track metrics showing how much revenue and gross profit you’re getting per employee. This can indicate that you have the right amount of staff who possess the right qualities.
These metrics can help you answer the question of whether or not you’re overloaded and if there’s an issue causing an employee to not be pulling their financial weight.
Lastly, take advantage of equity compensation as a mechanism to reward employees without utilizing the cash of the company.
Working capital is the amount of cash tied up in funding your business’s financial obligations. While you wait to get paid by your customers, working capital is necessary for paying:
Better working capital management can have a big impact on your cash flow.
A good indicator of a company’s cash flow health is the Net Working Capital (NWC) Ratio:
NWC Ratio = Current Assets / Current Liabilities
Generally speaking, an ideal ratio falls between 1.0 and 2.0. A ratio of 1.0 is quite low, meaning you have very little wiggle room in case of unexpected expenses or a customer should fail to pay on time.
On the other hand, 2.0 could be considered too high, especially if you’re in a growth phase. A ratio this high indicates you could be getting more out of your resources. Consider investing in more marketing, equipment, or people to get a better edge on your competition.
Eliminating all inventory likely won’t be possible. But getting closer to the “right” amount of inventory will reduce the amount of cash tied up in inventory.
Use digital, automated tools to track orders, deliveries, and sales to avoid shortages and overstocking. Avoid having too much product sitting on the shelves, without negatively affecting your ability to meet customer demand.
Less money flowing out (for the same level of revenue) automatically means better cash flow. Whether you focus on operational or overhead costs, improving expenses can boost both your bottom line and your cash flow.
Lower expenses can be achieved through:
Cash flow is a month-to-month, quarter-to-quarter measurement. But because owning is generally less expensive in the long run, a business may own too much and lease too little.
Although owning can make sense from a P&L perspective, it can create challenges in terms of cash flow. Leasing, on the other hand, allows for payment in small increments.
For example, a vehicle like a Ford Transit (purchase price: $25k-$50k) is a common business investment. A lease on the same vehicle could run $500-$800/mo.
Buying outright might be cheaper, but it can cause a cash flow issue. Paying in installments or leasing allows for far more flexibility and fluidity.
Developing good relationships with your suppliers, vendors, and customers can really give your business a leg-up.
While it takes effort to be a good partner, the payoffs can be massive. Better relationships can lead to better prices and volume discounts. Or, it could allow you to negotiate more favorable payment terms.
Cash management is critical for any business looking to succeed long-term. Without reliable cash flow, your startup will have trouble staying in business.
If you’re headed into a cash crunch, or just feel like your business cash flow could be improved, Founders CPA can help. Schedule a free consultation with our startup experts to see how you can better optimize your startup cash flow.