The "go-to" number for many a startup founder is net income in that some entrepreneurs believe that profit is the ultimate criterion in evaluating the soundness of a company's operations. But while an income statement that you create using accrual accounting does indicate the relationship of your company's revenue to its expenses, the financial statement does not allude to the amount of money your company has on hand. And because it "takes money to make money," cash-on-hand is a key differentiator between those companies that continue to operate from one year to the next and those that close their doors after only a year or two. So before you launch your startup, be aware of five issues that negatively affect your company's cash flow.
1. Unexpected events.
It's unlikely that when creating your company's business plan, you'll anticipate equipment failures or other operational emergencies. Likewise, it's doubtful you'll foresee the need to rethink your product offering or target market. But if consumers in your chosen market redirect their buying power to products you don't offer, you'll be forced to enter a new market or add new items to your product line. Also, if you identify a bottleneck in your production line that you must address by replacing certain equipment, you'll be facing a large capital expenditure. To prevent these types of scenarios from wreaking havoc with your cash flow, include six months operating expenses or more in your financial projections.
2.Unfavorable vendor terms.
If your startup is yet to establish business credit, it will receive less favorable credit terms than will a well-established business. For instance, a commercial building lessor might grant you a lease,but ask for a security deposit in addition to first and last month's rent. Likewise, phone and utility companies may ask for deposits. At the same time, your company's suppliers and vendors may ask for upfront payments for several months until such time that you establish a relationship with them. Only then will they offer your startup more reasonable terms.
3. Excessive reinvestment of profits in your company.
It's typical for startup owners to take the profits they earn in the early stages of their companies' life cycle and use it to grow their businesses. But the reinvestment of profits in your company's growth is a low-cost of capital only if doing so doesn't deplete your cash on hand to the point your startup can't pay day-to-day operating expenses. To avoid this disaster, carefully budget for outgoing expenses and set aside the cash needed to pay them.
4. Slow generation of revenue stream.
Some entrepreneurs make overly optimistic cash flow projections, while underestimating business costs. This budget issue becomes a problem when your startup's expenses far exceed its profits and you are unable to negotiate a line of credit to cover your company's operating expenses. Even if your sales forecast is accurate, the payments may not come in for several months, creating a short-term cash flow problem. You can prevent a cash shortfall by making a conservative sales forecast, creating a realistic budget that includes at least six months operating expenses in your financial projections, and setting aside cash reserves.
5. Late Paying Customers
According to a survey conducted by Fundbox, an online funding platform, about 50 percent of net-30 invoices issued by small businesses are paid late. Consequently, a stack of sales invoices doesn't ensure the financial health of your business. Even if your sales revenue is on a steep growth path, when a major portion of your customers pay their bills late, you can develop a serious cash flow problem. Credit and payment policies that increase cash flow by encouraging customers to pay their bills on time. For instance, you might require upfront payments of some customers, offer discounts to those who pay early and immediately contact customers with overdue invoices.
By creating a realistic budget and cash flow statement and carefully monitoring your cash flow, it becomes more likely you'll successfully negotiate any cash flow issues that arise in the first few years of operations and become a profitable going concern thereafter.