Helming your own startup gives you an incredible opportunity to steer your destiny. You can sell what you like, work when you like, and hire your dream team. You’re not beholden to anyone — however, you’re always beholden to the almighty dollar (or whichever unit of currency you happen to trade). More specifically, you’re beholden to your cash flow, which is a measure of your financial performance.
All business owners know they need to make money, but what many fail to realize is that the end goal of making money — earning a profit — shouldn’t be the primary concern for startups. Instead, what they need to concentrate on is cash flow. You can survive a lack of profit for a long time (depending on your funding and investment), but you can’t survive a lack of cash flow.
It’s surprising, then, that the term “cash flow” is shockingly unfamiliar to so many. Let’s address that issue by taking a closer look at what cash flow involves and why it’s so worthy of attention. Here’s the startup guide to staying solvent:
What is cash flow?
While there’s a lot of complexity attached to it, the basic concept of cash flow is incredibly straightforward: it’s simply the balance of your regular incoming payments with your regular outgoing payments. Having a good cash flow means ensuring that the money coming into your business each month is enough to cover the money leaving your business.
You might wonder how this is so different from profit, in which case you can look at it this way: it’s possible to be highly profitable in your business deals but spend so much on investing in the business (or simply living life) that you end up with negative cash flow. Cash flow isn’t about the ROI of specific deals — it’s about your business as a whole, and you need to be conservative.
What does cash flow mean for your business?
Your cash flow is the lifeblood of your business. Whenever you’re unsure how successful your day-to-day operation is, you can look at your cash flow to check that you’re bringing in more revenue than you’re spending. And if you’re consistently seeing negative cash flow — more going out than coming in — then you’re in major trouble.
In short, it’s a primary health indicator, and something that’s far more imminently important than profit. If you’ve been overlooking it, then you need to take action to address that immediately.
How to calculate your cash flow
The simplest way to calculate your cash flow is to create a spreadsheet in something like Google Sheets and tally up all of your regular payments: everything you pay out (subscription fees, food costs, space rental, etc.) versus everything you bring in (client payments). Add in the additional expenses that inevitably accrue, and you’ll see if you’re coming out on top.
If you just want a broad notion of your financial situation, you can stop there. If you want to get more in-depth with your calculations, Wave has a high-level guide about managing your cash flow that links to some useful template resources and formulae, so that’s a great place to start. Remember, though: only go to a level of detail that you can continue to monitor.
What happens if you have a cash flow problem?
Every month, your business will have numerous outgoing payments lined up (e.g. subscription fees, supply charges, office rent). These payments are collectively known as accounts payable (contrasting with accounts receivable referring to incoming payments).
Because recipients can have different preferences, they can ask for specific payment dates. One might want payment at the start of the month, while another might want it at the end. This adds complexity to your life, but makes it possible to spread out the costs.
Now imagine that a major payment you were expecting to receive is delayed, even though you need it immediately to cover one or more of those outgoing payments. Without it, you miss your payment deadline (or deadlines).
As a result, the service providers cut you off for the time being — but you rely on those services to manage your daily operations. As a result, you’re unable to trade, and unable to make money. With no money coming in, you start missing other payments, and soon enough you’re essentially dead in the water with a ruined reputation (reputation matters hugely these days — how you come across online can dictate your fate).
This is a rare scenario, and it’s possible to miss some payments and have nothing major go awry, but it’s possible. If your business relies on outgoing payments to keep operating, everything must be set up to guarantee that those payments are made.
How to optimize your cash flow
Now that we’ve established why cash flow matters so much, how do you optimize it to protect your startup from harm? Here are a few tips to help you make improvements:
- Hasten incomings, delay outgoings. It’s very common for businesses to provide payment windows — for instance, allowing a client to pay at any time during the last two weeks of a month. If you commit to paying on the 20th, then miss the payment, that’s a problem (and if you make the payment, it might deprive you of resources needed for something more important). Instead, make the payment date as late as possible. At the same time, push your clients to pay you earlier. This will tip the balance in your favor.
- Cut down on general expenditure. The less you spend, the less money you’ll need to make, and you’ll likely find that you’ve picked up some bad habits when it comes to business outgoings. For instance, if you keep ordering huge quantities of pizza when people are staying late, consider planning ahead and coming up with more economical ways of keeping everyone fed.
- Save up emergency funds. No matter how carefully you control your payment calendar, clients will miss payments. It’s an inevitability, all because emergency scenarios can never fully be avoided — and you need to be prepared. Think about how much money you’d need to get through the average month, and aim to save up at least that much as a reserve to protect you from total collapse.
Thankfully, getting your cash flow under control doesn’t need to be that hard, particularly when you’re still in the startup phase and can afford to be a little flexible. Just make sure to be careful — cash flow isn’t something to be taken lightly.
Kayleigh Alexandra is a content writer for Micro Startups — a site dedicated to spreading the word about startups and small businesses of all shapes and sizes. Visit the blog for the latest micro biz news and inspiring entrepreneurial stories. Follow us on Twitter @getmicrostarted.