T-shirts and Calculators: Cash Flow Management for Your Startup
by Joshua Lance, CPA, CGMA
There is one resource that is always in need for startups and that is cash. The nature of a startup is there is never enough cash. That is why it is critical for startups to properly manage the cash flow of their business. Its not enough just to peek at your bank account balance; there needs to be crucial processes in place to manage the cash flow of your business. The reality is that when the cash has dried up, the startup can’t survive. Here are three key things startups need to do to manage their cash.
Implement an Accounting System
I mention this in a lot of blogs I write, but this is an incredibly key step in proper cash flow management. If we don’t know how we are spending money or what invoices and bills we have outstanding, we cannot manage the cash flow for the startup. A proper cash flow management process needs an accounting system that provides us with how and where we have spent money in the past and what obligations that we have incurred, but not spent yet. For example, my bank account may show that I have $1000 in there, but it is not showing the two checks I wrote for $200 each and the bill we received for our web design for $500. If I don’t have an accounting system in place, I would look at my bank account balance and think I have $1000 to spend, when in reality I only have $100 to spend. An accounting system lets us see the obligations we have incurred and how that impacts our cash balance so that we have the true picture of our cash flow. A great accounting system I recommend for startups to use is Xero.
Forecast the Future
The next key thing for startups to do to manage their cash flows is to use a forecasting model or tool to understand where they think their business is going and how that impacts their cash flow. This allows you to make assumptions and what if scenarios to see where you may run into cash flow issues so you can better prepare for them and take steps now so that you don’t run into those issues. You can do this forecasting using an add-on to Xero like Crunchboards that take alot of the guesswork out of the forecasting and allows you to update the models on a real time basis. One thing to note here, is when you are creating a forecast make sure it is realistic. For example, if you are projecting to run out of cash in six months, don’t put in your forecast that you are going to receive investments from the magic investor fairy the day you run out of cash. That has a slim to none chance of ever happening and a potential investor that sees that in your projections won’t take you seriously. Another key part of this forecasting exercise is to look at two key metrics for your business. These metrics are your burn rate, which is the rate at which you spend your money in excess of income, and your runway, which is the amount of time you have before you run out of cash and your startup goes out of business. These two key metrics will provide you the hard truth if you are burning money too fast or you don’t have the cash to continue on in business.
Smooth out the cash flow bumps
You can implement an accounting system and have some strong financial models, but there will still be sometimes where you run into some short term cash flow issues. Maybe a customer unexpectedly tells you they will be five days late in making their payment and you were counting on those funds coming in so you can pay your employees timely. These short term issues can cause your major headaches if you don’t have some backup plans in place I really like a service called Fundbox that provides short term financing based on your outstanding invoices. You can also have a line of credit in place to pull from when needed to cover these short term cash flow bumps. That allows you to manage short term cash flow issues without a hitch.
Managing your cash flow is a critical process for your startup. Failure to manage your cash flows properly can cause your startup to shut down before you even get going. Implementing an accounting system, performing projections, and having short term cash flow backup plans will allow you to manage your cash flows effectively for your startup.