How can you identify potential cash flow problems for startups?

In an environment where funding is not readily available or too expensive, you need to know your cash inflows and outflows better than anything else. Having an expansive product roadmap is not going to be useful, if you cannot finance it. If you were not laser focused on your cash flows before, this would be a good time to start and implement a robust budgeting process. If you were focused on ‘growth at all costs’ in prior periods, you may want to take a fresh look at your business by implementing ‘zero-based budgeting’ in your first year. Once you have created your budget, make sure you have defined appropriate KPIs that are regularly monitored to avoid surprises.

Imagine you've started a tech startup that's building an app. You've got a team of developers, a small office space, some marketing spend, and more. Every month, you spend $50,000 but only make $20,000 in revenue. Your burn rate would be $50,000 - $20,000 = $30,000. That means you're spending $30,000 more than you're making each month. If you have $300,000 in the bank, you could technically survive for 10 months at this burn rate without any more money coming in. Funding Rounds: Sometimes, a high burn rate is acceptable if you're in the middle of rapid growth and planning to secure more funding soon. However, investors want to see that you have a plan to either become profitable or significantly grow revenue.

Cutting down any expense that does not lead to potential revenue is a good way to start looking at reducing the burn rate. Marketing expenses typically are a big bloat to any company burn and reducing that gives a significant run way upside.

Fundraising Timing: Knowing your cash runway helps in timing your fundraising activities. You don't want to be negotiating with investors when you're down to your last month of cash. Ideally, start the process when you have at least 6 months of runway left. Expense Control: Often, startups focus only on revenue generation and neglect expense management. Knowing your runway can trigger cost-saving measures, like negotiating lower vendor prices or even cutting non-critical projects. Pivoting: Your cash runway can also be an indicator that a pivot might be needed. If your runway is short and there's no sight of rapid revenue growth or investment, it might be time to rethink your business model.

Startups very often overestimate their ability to generate revenue. At the same time, they underestimate how much it will cost to grow their business. Founders also underestimate how long sales cycles can last. Before you start in the market, get an idea of what the rules are in the market, what the sales and budget cycles look like in companies, what the price level is, and the volume of orders. Based on this, form a plan. The old advice of every entrepreneur: divide revenues by three and multiply costs by three times and you will be closer to what you may face in the market.

Imagine you own a small coffee shop. You forecast that you'll sell 200 cups of coffee every day at $4 a cup. That's $800 in revenue per day. Your expenses, like staff wages, coffee beans, and rent, come up to $600 a day. Your forecast shows you'll have a positive cash flow of $200 per day. But suddenly, a big coffee chain opens next door. Now, you're only selling 100 cups a day, cutting your forecasted revenue in half. You'll need to re-evaluate your cash flow forecast to avoid running into problems. Scenario Planning: One of the best ways to use cash flow forecasting is by creating different scenarios. What if your revenue decreases by 20%? What if your supplier raises prices? Knowing the answers can help you prepare for challenges.

Imagine you run a digital marketing agency. You've completed a big project for a client and sent them an invoice for $20,000, with terms that state they need to pay within 30 days. Meanwhile, you owe $5,000 to freelance designers you contracted for the project, and their payment is due in two weeks. If the client takes 45 days to pay (breaking the agreed-upon terms), but you have to pay your freelancers in 14 days, you're in a cash crunch. This kind of mismatch can be dangerous and disrupt your cash flow. Importance of Terms: Net 30 or Net 60 determines how quickly you'll have cash in hand or need to pay out cash.

Let's say you're running an e-commerce startup. You have $100,000 in your coffers and you need to decide where to invest it. Option A is to pour all the money into marketing, hoping to acquire tons of new customers. Option B is to spend half on marketing and half on improving your product features, based on customer feedback. You choose Option B. Three months later, not only have you attracted new customers, but your existing customer base is also more satisfied and making repeat purchases. You've effectively optimized your spending and investing by evaluating ROI and taking a balanced approach. Opportunity Costs: Always consider what else you could be doing with that money and whether it might have a better ROI.

Prior to raising capital, understand your goal, not how you're going to spend that capital. Every pitch deck will include a slide that shows where money will be spent. A better approach is to clearly define what you aim to achieve from the round. For example, PMF. Then define what PMF would look like. The biggest advantage here is that it prevents scope creep. Which is one reason for your burn to increase. Second, maintain a small, effective team. It's much better to pay a premium and hire an expert VS hiring 5 people to generate the expected outcomes of an expert.