Posted by Early Growth
December 11, 2014 | 6-minute read (1153 words)
If you missed our recent webinar on lean cash flow or just want a refresher, keep reading for a recap. You can also access the deck on SlideShare: Lean Cash Flow: Simple Steps to Better Startup Cash Management.
What is Lean Cash Flow?
What is “lean cash flow?” We think of the concept of lean cash flow as an offshoot of Eric Ries’ Lean Startup principles. It’s an unfortunate fact that most startups fail. A lot of the time, this is due to a misunderstanding of what customers need. Lean startup principles try to maximize startups’ chances of success by positing a step-by-step process involving a feedback loop of testing assumptions, learning from early users, and pivoting as often as necessary.
At the end of the day though, most startups that fail run out of cash. Managing for lean cash flow means understanding where you’re spending money and being able to adapt to changing circumstances as and when you need to. This starts with creating your financial model, which allows you to plan properly. Your forecast should cover an 18 month timeframe. That’s also the same amount of cash runway you should give yourself going into a raise.
Building Your Financial Model
As you work on your model, keep in mind that your assumptions should underpin and drive your entire financial model.
If you don’t have much of an operating history to work with, do research to find comparable industry examples you can use as guidelines in building your model. Company filings are great sources and data on things like typical spending on R&D, sales and marketing, and headcount.
Questions to ask yourself:
- What’s your business model?
- How will you generate revenue?
- How much effort will it take, in time and money, to develop your product?
How much cash flow will you need to start generating revenue?
- Will you need to spend on advertising (local, paid campaigns, pay per click, salespeople)?
As you’re creating your financial model, you’ll find a few key variables are the main drivers. I’m talking about things like headcount, customer acquisition costs, and/or revenue. Your level of detail is important, but make sure you spend your time wisely. When it comes to key assumptions/variables, I follow the 10/90 rule: getting to 90% accuracy should take 10% of your time and focus. Don’t flip the proportions by spending 90% of your time trying to get that last 10% right. And get help building your model if you need to.
Updating Your Cash Flow Forecast
Once you have a working model, you’re not done! Models are not static. At a minimum, you should update your cash flow forecast: comparing actuals to budgeted amounts on a monthly basis. Going through this iterative process every month, and especially whenever you’re making big decisions, will give you more data points and sharpen your understanding of what drives your business.
The pre-revenue phase is a good time to use a hybrid model: one where you take your income statement as a starting point. You’ll run things like payroll expenses and consulting fees through your income statement, recording amounts for cash disbursements and spending on things like capex, purchasing inventory, and rent/security deposits.
This can make sense and come very close to being accurate in cases where your income statement accurately represents your cash flow: for instance, with SaaS businesses where customers pay on a monthly basis. But only looking at the income statement can get you into trouble because revenues do not
equal cash. And in most cases you need to put together a full set of financial statements including: an income statement (revenue, COGS, operating expenses), balance sheet, and cash flow statement.
Managing For Lean Cash Flow
Once your model’s done, you still need to manage your actual cash. Here are some ways to stay lean while still growing your business.
- Pay attention to your expenses. Hiring will be your biggest expense, so make sure the timing, amounts, and salaries are right for where you are. Considering all the other costs over and above those for direct compensation — PTO, benefits, and recruiting — hiring an outside consultant in the early days can be cheaper than adding full-time employees.
- Know how Accounts Payable (A/P) and Accounts Receivable (A/R) affect your cash position. As your A/P increases, so does your cash position. Setting up payment plans with vendors, pushing for net 30 days terms, and paying with credit cards are great strategies for lean cash management. Not only can debt can be a great source of financing, the earlier you establish your credit history, the better. Conversely, increases in A/R suck up cash. Be as aggressive as possible in collecting cash upfront from customers. Billing automatically via credit card is great. Push for cash on delivery or for short terms. And don’t let receivables linger. Send reminder notices before payment due dates to try to minimize late payments.
- Keep track of your financial commitments and put an approval process in place for spending — before you part with cash. Legal fees in particular can get startups into trouble. Law firms are notorious for long and late billing cycles.
- Track how much cash you have in the bank. Stay on top of your run rate so that you know when you’re going to run out of cash, and know what your cash flow will look like over a 6-12 month time horizon. Get help if you don’t have the wherewithal to manage this.
- Push out spending where you can and cut costs where you can. You should be ready to have the discussion with investors as early as possible of what you did, why you did it, and what you’re going to do about it.
You’ll know when it’s time to bring in a professional — it’ll be once you reach an obvious pain point. Until then stay flexible, keep it simple, and make sure your financial model is always driven by your assumptions about the business.
Need help managing your startup cash flow? Tell us about it in the comments section below or contact Early Growth Financial Services for advice on managing your startup cash flow.
Deborah Adeyanju is Content Strategist & Social Media Manager at Early Growth Financial Services, an outsourced financial services firm that provides small to mid-sized companies with day-to-day accounting, strategic finance, CFO, tax, and valuation services and support. Deborah is a Chartered Financial Analyst (CFA) charterholder with more than a decade of experience as an investment analyst and portfolio manager in New York, London, and Paris.
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