How Does a Startup Prevent Cash Flow Problems

It’s no surprise that startup cash flow is a key concern of any founder. After all, running out of money is one of the top reasons why new businesses fail. In fact, 82% of businesses who have closed their doors have cited poor cash flow as the cause. When businesses are just getting started, it can be hard to gain traction and enough sales to have a positive cash flow.

Of course, not having enough cash in the bank is stressful for any startup founder, but a lack of capital will also affect your ability to pay for payroll, expenses, and overhead. It’s tough to face such a high statistic, but there are steps that you can take as a startup founder to avoid cash flow problems in the first place. I’m diving into some of the main cash flow issues new startups face and how you can prevent them.

9 Cash Flow Issues Startups Face:

 

The Issue: You’re Overspending

The saying goes, “you need to spend money to make money,” but the reality when you’re just starting up is that you need to keep a really close eye on your spending. Overspending on travel, business lunches, office equipment, and software can quickly add up and put your business under really quickly.

The Solution: Be Ruthless With Your Cost-Cutting

Before you start spending, take two steps: sit down and set your budget, then decide what the absolute minimal things you truly need to run your startup. Be ruthless: negotiate with vendors that you absolutely need, hire the bare minimum staff for what you need, or outsource which can cost less than a permanent staff member, and find out if any of your necessary vendors offer special rates or discounts for new startups to keep your costs down.

The Issue: Your Bookkeeping Has Errors

As your startup starts making money, it can be intimidating to keep the books organized where there are so many other priorities, and it can quickly get to a point where you’re overwhelmed, and the numbers don’t add up. Once things go off the rails, it can be a huge hassle and take up even more time and energy to figure out where things went wrong.

The Solution: Get The Help You Need

If you’re not good with numbers or don’t have the time to deal with the bookkeeping, it’s best to get a professional on board to do it for you. There are too many things that startups need to pay attention to without having to worry about the mundane task of bookkeeping. While outsourcing does cost money, it is often worth hiring someone to do it for you.

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The Issue: You Haven’t Set Financial Goals

It can be easy to spend a lot at the beginning of a new venture and to quickly run low on cash before even being able to earn money. It’s tough to estimate how much you’ll have to spend, but if you spend too little, you won’t have the things you need to succeed, and if you spend too much, you won’t be able to pay your bills.

The Solution: Plan Ahead

Even if you can make a rough estimate from the little data you have, it’ll be better than nothing to get started. Gather your monthly expenses and create a startup cash flow forecast for your business, even if it’s just a spreadsheet. Predict your costs for the next 6 or 12 months to help you better understand your financial situation. Set realistic financial goals that you can follow, and stick to them. Do a monthly forecast review to know how your cash flow runs in relation to your estimated budget. This will help you refine the process over time.

The Issue: You’ve Given Up Too Much Equity

Starting up a new venture can be an exciting time, and it can be especially exhilarating when people want to invest in your business. While investments can be a nice influx of capital, it also means you have to give up some of the equity in your business. It can be tempting to take on a lot of investors to keep the business operational and increase your cash flow. Doing this is probably not in your best interest in the long run because it dilutes your business early or means that you will have less equity in your own business in the long run.

 

The Solution: Take it Slow

Make sure to think carefully about the investors that you take on and how much equity you’re willing to give up. Before you start handing out equity for investment, define how much you’re going to need and organize a cap table to see what your dilution will look like with real numbers. You can also offer investors other benefits aside from equity, and most importantly—be mindful of who you’re bringing on as an investor.

The Issue: You Haven’t Explored Credit Options

When a new business is just starting out, it’s easy to hit startup cash flow shortages when more money flows out than in. Applying for financing can be a lifesaver for any new business to bring more cash flow in quickly. While credit can be costly when interest rates are involved, it can provide immediate relief to struggling startups.

The Solution: Allow for Spending Flexibility

Getting a line of credit early in your business so you can have the flexibility to handle startup cash flow fluctuations. Of course, it won’t help if your business has long-term cash flow issues, but it can help for short-term issues or ups and downs in sales.

The Issue: You Expect Immediate Results

When starting a business, many founders invest their own money and hope to generate a profit sooner rather than later. The truth is that most businesses don’t start turning a profit right away. Even if you forecast your sales accurately and hit your goals, customer payments may not come in right away, creating a cash flow problem.

The Solution: Be Patient and Realistic

When advising new businesses, I recommend that founders make conservative sales forecasts and be realistic with budgets for the first few months or even a year. In addition, I recommend that startups run lean operations and don’t spend too much from the get-go—you need to be careful when making big purchases or bring on team members so that you can manage your startup cash flow more easily.

The Issue: You’ve Overextended Yourself

Many new startups face both expected and unexpected expenses. Whether it’s payroll, office expenses, technology, or other overhead costs, your costs could lead you to run out of liquidity quickly. This could mean that one bad month could put you in a position where you can’t make payroll or pay rent at your office.

The Solution: Keep Your Overhead in Check

It can be easy to spend when you know you need to invest in your business, but when you’re starting out, it’s important for you to plan ahead and make sure you’re managing your cash appropriately. Keep your fixed costs and overhead to a minimum, and only make purchases that are absolutely necessary as you grow—this will ensure that you can maintain your cash flow until revenue supports your growth.

The Issue: Your Customers Don’t Pay You Up Front

In the U.S., there is $3.1 trillion in B2B receivables owed at any given time—that means all businesses have stacks of unpaid sales invoices. For established businesses, this might be ok, but for new startups, late or unpaid bills can create a severe cash flow problem.

The Solution: Keep Customers Accountable

Put credit and payment policies into place that encourage customers to pay their bills on time to keep them accountable. You can even put policies into place that speed up your cash receivables. For example:

  • Accept prepaid pre-orders
  • Ask customers for partial payments or deposits
  • Send invoices immediately or more frequently
  • Make it easy for customers to pay
  • Give discounts for upfront, full, or early payments
  • Discourage late payments with late fees or interest
  • Stay on top of overdue invoices

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The Issue: You’re Not Ready for the Ups and Downs

Market conditions, seasonality, fluctuating demand—these are just a couple of things that could affect sales, and therefore cash flow. Some things are predictable and can be forecasted, some things are completely unexpected and can quickly take a new business owner by surprise. There’s no way any startup could have predicted the COVID-19 pandemic and how shutdowns affected businesses. It’s essential to keep emergencies at the front of mind when starting a business.

The Solution: Plan for the Unexpected

Set aside a cash buffer in case of emergency—the more prepared you are, the less stressful it will be when unexpected issues arise. You never know what might come up, and the first year is a crucial time for a startup—being prepared for the worst means that your business might make it past the initial barriers and thrive well into the future.

Conclusion

Starting a new business isn’t easy—even in the most positive and entrepreneur-friendly startup environment, many businesses still struggle with startup cash flow because they’re not prepared or hit speed bumps. I’m here to help advise you through the processes, to get your plan flowing before you even get started.

If you’re looking for more advice on how to get started and what outside services you might need, check out my blog: The Key Outside Services Founders Need for Their Startups, or contact me to build a strategic partnership with invaluable insights into starting a new business, the world of angel investing, and more.

 

Jonathan Hung, Angel InvestorAbout the Author

Jonathan Hung is one of the most active angel investors in Southern California, his mission is to drive value creation within each portfolio company. In support of this mission, he serves as Co-Managing Partner at – Unicorn Venture Partners.

Jonathan and his team target investments in US companies that have global market potential with a focus on long-term growth expansion to East Asian markets.

Jonathan developed his investing prowess as a Managing Member for his family office fund, J Heart Ventures, which made investments in start-up companies such as Gyft, ChowNow, Miso Robotics, Clover Health, Bitmain, to name a few startups he funded.

Jonathan has various degrees from the University of Southern California, London School of Economics, Massachusetts Institute of Technology, and The Wharton School at the University of Pennsylvania.