Tim Bates, Dan Kinsella,
Jim Moar & Kent Lillemoe
for the MESA Organisation
A Call to Arms about Cash Management
For many companies, time is money. For early-stage companies, money is time. This framework underscores this brutal reality.
You need loyal customers and super-duper products for startup success. However, they're rendered useless if you don't respect the fact that cash will always be king, and you need it to survive.
A simple truth, cash-flow surprises kill many startups. One out of three startups dies from a cash crisis. Therefore, as an entrepreneur, you need to understand and, more importantly, master cash management basics before mismanagement bites you in the ass or, worse, puts you out of business.
In its simplest form, proper cash management means controlling your inflows and outflows of cash, so you never run out!
Here, we outline seven fundamental concepts of cash management that every startup founder must adhere to to minimize cash-flow crises or an all-out business implosion.
1. Create a culture of cash awareness. Describe how you and your organization are cash aware, e.g., with spending.
2. Have a capable, experienced financial person who is your cash champion, even if at a point where only a part-time financial person can be afforded.
So, here's the main problem many growing startups have. The founders manage money – tracking, handling, and making payments. However, managing money is a time-consuming task, and it eats up energy. If you are truly honest with yourself and you are running a growing business, managing money is an energy vampire. It consumes time and energy and only leaves a small amount for growing and promoting the business. No matter how great you are with money, your attention and time are always in demand. At some point, you will get distracted and drop the ball in this crucial area where you can least afford to do so. Get help!
3. Create a cash forecast: This is equal to or more important than an income statement forecast. Test your assumptions, especially the impact of higher or lower sales than your base forecast. Develop a detailed cash budget and stick to It.
This means working through robust cash flow reporting to know where you are today and where you will be in six to twelve months. Create a realistic cash flow budget that charts finances for the short and longer-term.
A cash flow forecast needs to include your fixed and variable costs, sales revenue, and any other forms of income and funding. If you spot any hurdles ahead, you should have plenty of time to work out whether you can jump them, or whether you need to seek outside help to leap over them.
Be realistic with your sales volume estimates. It's important to be optimistic in the startup business, but not when predicting cash inflows from deals. When you gather your numbers together to create your cash flow forecast, make sure you are realistic with your sales figures. Being realistic is important because optimism has been known to obscure a future cash flow problem. It's better to err on the side of caution when it comes to having cash and knowing the amount that can and will be on hand at all times. It's challenging to predict your sales levels if you have no history to base it on, or if your business is experiencing rapid growth. Seek outside expertise in these instances, someone who has experience supporting similar businesses. Their insight will help you to keep your predictions realistic.
4. Identify what events and scenarios will cause you to run out of cash inside of 12 months. Model up different scenarios that would allow you to extend your cash runway should you need to do so.
Cash is King. Cash is air! You and your company need cash to survive. Don't run out of it! A fundamental cash management principle for startups is to run cash lean. This means managing your spend. Your business needs cash to survive, so your primary job is to protect and build your cash reserves. So being able to prioritize spending is crucial, and knowing what's necessary vs. "nice to have" can make the difference between success and going bust.Know your cash runway. Start planning to acquire the cash you will need before you need it. Know what your cash runway is and how long you have until you run out. It's a sure bet that you will need it. So, know when that will be or might be.
The Big Deal – Remember, don't bite off more than you can handle
Cash flow management is all about timing. For most startups, the prospect of a significant new deal is irresistible. Saying yes and figuring out what to do later can be heroic, but it can sometimes spell serious trouble for the company in terms of cash flow. Hence, turning down or postponing work that can negatively impact cash may be the wiser option if the costs involved to deliver a project are particularly high. Try offering a discount for delaying or extending the deadline for the order or service. It will give you more time and lessen the burden on cash flow.
Rainy Day Reserves – They are always a good idea
The startup process is unpredictable, and unless you're ready to call it a day when you encounter that first bump in the road, always ensure that you have a reserve of cash on hand. Unpredictable means unpredictable. Having a cash reserve for a critical pivot or some other unforeseen chaotic event will decrease stress and helps you focus on that most crucial thing; growing your business! A cash reserve is that all-important survival kit for startups.
5. Understand the impact of receivables collection on cash. How are you going to get paid? How are you going to collect? How can you get paid upfront?
The Collection and Payment of Cash – Be Aggressive and be diligent. As an entrepreneur, the general cash management rule of thumb is you delay every outlay of cash as long as possible while encouraging those who owe you money to pay it as soon as possible, even before they owe it. The corollary is always, always, always work at getting the best collection or payment terms on all deals you are working.
Manage your receivables carefully. Don't put yourself in a position where you have to take on expensive debt for working capital because you have outstanding Account Receivables. Make sure that payment terms are clearly defined to your customers, along with the related fees charged on late payments. Create a clear framework around the issuing and management of invoices, so both you and your customers know what to expect.
Regular communication is the most essential and most effective way of getting your customers to pay on time. Being in touch regularly will ensure you are at the front of your customer's mind and will give you lots of opportunities to remind them about due or overdue payments. It will also allow your customers to raise any issues they may have with competing payments.
However, be an aggressive cash collector. Make all invoices "due immediately" and move towards automated charging as soon as possible. (Note that the market may not allow this but let this be your standard starting point.) In other words, collect as much upfront as you can. Ignore the usual terms of 20% down and the rest on delivery. Start with 100% upfront terms. 100% upfront is not an unrealistic ask. When you can't collect it all, collect what you can! Consider compromising on some billing disputes with clients. Obtaining some cash on any products sold or services rendered is better than not collecting anything at all. Even good customers make late payments, stay on top of your collections! Make it the first thing you do in the morning and the last thing you do at night. Redouble efforts to collect outstanding payments owed to the company.
Be an aggressively slow payer, but also communicate with your creditors. In a cash shortage, contact creditors (vendors, lenders, landlords) and attempt to negotiate mutually satisfactory arrangements that will enable the business to weather the crisis. Communicating with anyone you owe money to is highly recommended. For any creditor, any payment is better than none. If you show that you are willing to pay something, then they will likely work with you.
In some cases, you may be able to arrange better payment terms from suppliers or banks. Better credit terms translate into borrowing money interest-free. An order or contract is not the same as cash. Don't confuse the two. So, in a startup, where salespeople are paid on commission, only pay them when money is collected from the customer. The benefit of this is that it makes the salespeople responsible for the collection of cash and sensitive to the quality of the deal.
People don't always pay. It's a reality of business. Even bankers and investors may withhold funds. So, assume the worse, and plan for it. Anything else will be a happy surprise.
6. Identify lead metrics toward attaining your revenue goal as one of the primary elements of meeting your cash forecast.
7. What are your financing assumptions, and why? Identify lead metrics and milestones critical to be ready to raise funds.
Assume it will take longer than you think. Note: there will be a separate template on Financing. Know where you can acquire cash. Plan on how you will obtain it. And depending on the stage and type of company you run, and other factors, you may have access to different sources of capital. (Sales, banks, investors, grants, etc.) Know what these are, and start nurturing these relationships now! Getting access to this cash requires planning, time and effort. Hence, you will need cash to get cash from these sources. (For example, if you have a growing and exciting startup, it can take on average 6-months to raise cash from a VC.)