Managing cash flow is important for business owners in the startup phase because they will experience many financial issues and concerns that established businesses do not. But many entrepreneurs aren’t prepared for the challenge, and 90 percent of small businesses fail because of poor cash flow. If you’re about to launch a new business, here are five areas you should pay attention to so you are not caught off guard.
1. Unexpected Pivots and Emergencies
No matter how well thought out your business plan is, you can’t predict when an emergency will happen or when you’ll have to pivot to keep your business on track. For example, if your product isn’t selling as you anticipated, you may have to invest in repackaging it or in reaching a different market. Likewise, if you have a major equipment failure, you may not be able to manufacture your goods until it has been repaired or replaced, and that will take capital. In order to prevent these types of scenarios from wreaking havoc on your cash flow, you should include some cash reserves in your financial projections. Money expert Dave Ramsey recommends that businesses have six months of operating expenses set aside when starting out.
2. Unfavorable Terms
Because startups don’t have established business credit, they will not receive the same terms as an existing business. For instance, you may be required to give a security deposit plus first and last month’s rent for your new business lease, and utility and phone companies may also require deposits. In addition, vendors and suppliers may ask you to pay upfront for products for the first few months until you have an established relationship with them and they can offer you more traditional terms.
3. Reinvesting all the Profits
Startups need capital to grow, and many times that capital comes from the profits they earn in the early stages of business. While it’s typically necessary to reinvest profits in the company in order to see growth, some entrepreneurs get into cash flow trouble when they don’t reserve enough of their profits for operating expenses. In order to avoid this trap, pay close attention to your budget for outgoing expenses and be sure to set aside enough of your profits to pay them.
4. Slow to Start Sales
When creating cash flow projections, many entrepreneurs are overly optimistic about how many sales they’ll make and are too conservative about what it will cost to run their business. In addition, because new businesses typically don’t have access to the lines of credit that more established businesses do, when expenses eclipse profits, it creates a cash flow gap, which can put a fledgling business in jeopardy. Your sales forecasts may be accurate, but instead of coming in right away, those anticipated sales may not come in for six months, and that will create a short-term cash flow problem. Prevent this from happening by being conservative with your anticipated sales estimates and realistic about your expenses — and don’t forget to set aside the cash reserves we talked about earlier.
5. Late Paying Customers
Just because you are making money on paper, that doesn’t mean your business is financially healthy. Startups can have serious cash flow problems even when they are making sales if customers aren’t paying their bills on time. Prevent late payments by creating payment policies that increase cash flow, such as requiring upfront payments or offering discounts for customers who pay early, and making sure you’re diligent about overdue invoices.
With proper planning and a steady eye on your cash flow, it is possible to maneuver your startup through the first few risky years and come out profitable.