by Anand Srinivasan, founder of LeadJoint.com
At the outset, managing the cash flow for your business seems like a no-brainer. It is not too difficult to realize that your expenses should not be more than your income. But things are not this straight-forward in real life. Take the example of a typical agency that provides marketing services to clients. Assume that this agency cumulatively bills its customers $50,000 a month in retainers and spends around $40,000 a month on contractors, debt payment, payroll and office rentals. At first look, this appears to be a healthy business that pockets a neat $10,000 in profit each month.
But things may not be this rosy after all. Mortgage payment, payroll and office rentals are expenses that need to be made each month without fail. However, depending on the payment terms you set with your clients, they may enjoy a net period of anywhere between a week to ninety days to make their payment. In effect, by the time you receive the $50,000 retainers for a month, you may have had to pay over $100,000 in monthly expenses. We have barely scratched the surface when it comes to business operations. The net outflow during any given month is likely to be impacted by other factors like the end of a contract, taxes, holidays and other circumstances.
According to Marcus Roberts, financial advisor and owner of Sydney-based Mirador Wealth, one of the primary reasons startup businesses fold before they gain traction is due to bad cash-flow management. In a brief email interview, Marcus told me that the exponential growth of businesses like Facebook, AirBNB and Uber from small-time start-ups to billion dollar companies has shifted the scales in favor of scalability over sustainability. “Startup founders all see their products as the next Facebook or Uber. It is a good thing to dream big. But by not scaling up in a sustainable manner, these businesses often accumulate too much expenditure without making enough revenue. The result is that the CEOs of these companies end up spending most of their time finding a source for their next funding. When that does not happen, there is no way to pay bills and the companies fold even before they can take off”.
Marcus is not alone in this assessment. In fact, according to a study by Dunn & Bradstreet, nearly 90% of small-business failures is caused by poor cash flow management. In a lot of these cases, the businesses pay their vendors to get their supplies. But then, they often have to wait months before getting paid. How you manage this interim period needs extremely smart planning and financial acumen.
So how does one go about managing cash flow better? Here are a few pointers to keep in mind:
Sustainability > Scalability.
There are a lot of businesses where the only way to make money is through economies of scale. In such cases, it sure makes sense to scale up before expecting returns. But in doing this, you need to acknowledge that this is not sustainable, especially given the uncertain nature of business. A better strategy would be to launch a product of value that is not price-sensitive and channel the profits from this business into your low-margin, high volume business. This way, you can tide over uncertainties and have a better hold of your finances even when scaling up.
Audit your expenses.
I recently received a charge-back from a customer who I thought was a loyal customer who I have regularly interacted with for over a year. Turned out, they did not exactly remember signing up for my product and only communicated with me as an industry acquaintance. Auditing your expenses on a monthly basis is absolutely critical to ensure that your expenses are not more than what they should be. If you are in a business with low margins, every dollar counts and can easily add up to be the difference between your business holding up in terms of crisis and folding out.
Common sensible payment terms.
As far as possible, work out payment terms that are consistent. If you have a Net 30 invoice terms with your client, make sure you have a similar arrangement with your vendors as well. This helps you maintain a steady cash flow cycle. Of course, there are fixed monthly expenses like mortgage and payroll that can skew this cycle. As a result, this pointer alone is not sufficient to maintain a healthy cash-flow cycle. But when done in tandem with the other pointers, you can be well on your way to ensure a healthy and sustainable business with strong cash flow management.
Anand Srinivasan is the founder of LeadJoint.com, an online lead generation tool for digital marketing agencies. He is also a part-time marketing consultant and has previously worked with some of the most promising Indian startups.