One of the most important processes that any founder and his core team need to understand is cash flow, because poor cash flow management can lead to untimely death of a great idea and a well thought out business plan.
Many people ask us what is cash flow, how can a startup achieve a healthy cash flow etc. To make it easier to understand it, we have a series of question-answers below.
What is cash flow management?
For any start-up to be able to build a sustainable business, it must cross the initial stage of “Survival”. Quite often, start-ups run out of fuel despite an attractive value proposition due to poor cash-flow management.
Cash is required for day-to-day expenses and in particular for retaining talent. A delay in paying salaries can send fairly wrong signals, if not handled personally by the founders. The founding CEO of a start-up must have a close eye on the daily cash position. It is much more pertinent than the profit and loss account or the balance sheet at the early stage. For instance, in a high-margin product sold on credit the start-ups inability to realize timely payment from a customer could be highly damaging.
How is cash flow calculated?
For cash flow management, one need not be qualified accountant. It is a simple addition and subtraction of opening balance, planned receipts and payment, and the closing balance. Planned receipts could include shareholders equity contribution, secured or unsecured loans, revenue receipts, collections from customers for past sales and the best source is customer advance.
How often does one track cash flow?
It is advisable to review the cash flow every week while planning instantly for mismatches or unforeseen events. There is nothing wrong in reviewing it on daily basis, for a while. This will help where external funding is required, so planning for raising a fund in current environment must start at least 9-12 months in advance.
Can a startup make a cash-flow forecast?
A start-up must have a cash flow forecast with every possible contingency catered for, before initiating the venture. A simple common sense approach is great to take the first few steps.
How can a startup undertake smart cash flow management and improve cash flow in a crunch?
The best solution is an advance for the customer. A start-up normally comes up with a novel product or solution or service. It must be in a position to negotiate an advance for its services. Multiple start-ups have succeeded in achieving this milestone. For any cash crunch situation, it must have founders, family and friends on the stand-by. A proposal ready for an Angel Investors to be the co-investors would be great. Angel investors in their individual capacity can provide quick solutions. They can act as fast as Milkha Singh.
For a product or retail business, is managing inventory important to be on top of their cash flows?
Working capital has two key components – Inventory and Debtors. In a retail business, a start-up is fortunate as most of the sales are realized in cash or at the most realizable through credit card partner. It is the inventory planning that is of utmost importance. A start-up cannot afford to be holding non-moving or slow-moving inventory. In early days it may be better to be out-of-stock rather than sit on slow-moving inventory. Best deals are consignment sales or having a flexibility to return the stock to the manufacturer in case the forecast or plan is in accurate.
When dealing with suppliers or creditors, what strategies can one adopt?
A start-up must share its long-term vision with its supply partners. Its unique plan to grow big with the support of vendors as value partners must be clearly communicated. The founder must win their heart and mind by articulating his approach to selling their product in a highly competitive market. If a start-up is able to win the suppliers loyalty, it can aspire to get clean credit. This is the credit that is given to a startup without the support of a bank guarantee, or a letter of credit, or an advance. The founder’s credibility plays a significant role in dealing with suppliers.
How does a startup improve cash flow by receiving payments on time or receiving upfront payments?
A start-up usually fails to build processes for collection of payment. It has a sales team that is already stretched in meeting targets. It may not have a finance person to keep track of each invoice or to follow-up.
We have observed that sometimes a start-up even fails to raise an invoice on time. Second, the follow-up process doesn’t not start, say 15 days minus the due-date. Every payment howsoever small or any receivable, from even a highly reputed customer, requires a constant follow-up with the receiver of services, the accountant, and the signatories. The earlier these roles are planned the better off the startup is, in its cash flow management.
[This post was originally appeared on Yournest blog. Yournest is an early stage venture capital fund, investing in businesses built on vibrant and new ideas enabled by path-breaking use of technology.]
