If you’re the owner of a new startup, you should know that running out of money is one of the biggest reasons new startups fail. But your new business doesn’t have to become a statistic if you pay close attention to your cash flow. Here are five ways you can manage it and give yourself the best chance of success.
1. Calculate Your Burn Rate
In order to keep a handle on your cash flow, you need to understand your burn rate right from the beginning. In a nutshell, your gross burn rate is the amount of cash you spend every month in order to keep your business running. For example, if it takes $2,000 a month to keep your doors open, that’s your gross burn rate. This tells you how long your business can remain open before you run out of money. If you have $10,000 in cash reserves, and you spend $2,000 a month, you will be out of money in five months if you have no revenues.
In addition to calculating your gross burn rate, you also need to get a handle on your net burn rate, which is the amount of money you lose each month if your business is not yet profitable. Do this by subtracting your revenue from your expenses. If you spend $2,000 per month and have $1,000 in income, your net burn rate is $1,000 per month. This is valuable information you can use to determine how long you can operate unprofitably before you run out of cash — ten months in the above example. It can also be used as a guideline of when to approach investors for additional capital.
2. Only Spend on Essential Operations Until You’re Profitable
Now that you know how many months you can operate on your existing capital, it’s important to take a good look at your expenses and eliminate any that aren’t essential. For example, developing that mobile app for your customer’s convenience may be a cool idea, but if it won’t immediately add to your revenue, you may want to put it off until your business becomes profitable. In order to make it through this vulnerable time in the life of a startup, stick to essential operational expenses, and put the “cool” stuff on the back burner.
3. Don’t Hire Until You Absolutely Must
Employee salaries and expenses can quickly burn through your cash reserves. In fact, the U.C. Berkeley Institute for Research on Labor and Employment says that in addition to wages and salary, it costs on average $4,000 to hire an employee. Luckily, you don’t have to bring on full-time help in order to get help running your business. Independent contractors and freelancers have become a major factor in helping many small businesses reduce their operating expenses and hang on to their cash reserves. You can find freelancers for just about any job you need filled on sites like Upwork. But be sure you don’t make the expensive mistake of wrongly classifying an employee as an independent contractor. The Department of Labor publishes some clear guidelines on the subject.
4. Offer Customers a Discount to Pay Early
Ask any seasoned business owner, and they will tell you one of the biggest dangers to your cash flow is a stack of unpaid accounts receivable. You can try to prevent this from happening by offering customers a small discount if they pay early. The early payments will ensure that your cash continues to flow in the right direction. One key to success in this type of arrangement is to make sure your customers understand the option at the point of purchase, not when they receive the invoice. This will allow them time to think about it, and if they’re signing a contract, commit to an early payment.
5. Ask for a Deposit or Money Upfront When Accepting Large Orders
Consumers have come to expect to give deposits for many types of purchases, and if you base your business on this model, it’s an easy way to improve your cash flow. Depending on your type of business, you can ask for 50 to 100 percent upfront when customers place an order. This works especially well if you need to purchase materials to complete a job because it allows you to use the customer’s cash for the purchase instead of relying on supplier financing or your cash reserves.
Keeping your cash flow healthy is one of the most important things you can do while growing your startup. Use these tips to avoid being just another startup that ran out of cash and had to close the doors.