Every company deals with 2 types of cash: the cash it receives, such as profits and revenues, and the cash it spends on its financial liabilities, such as costs and expenses. It's essential for every company to understand the extent of its cash flow, so it can determine whether it's positive or negative.
A positive cash flow indicates that the company is financially stable and is on the right track; a successful company is one that succeeds at maintaining a positive cash flow. On the other hand, a company is said to have a negative cash flow when its liabilities and expenses exceed its profits and when it is unable to make payments; this means that the company is suffering from a deficit or a crisis in its cash flow.
What Is the Definition of Cash Flow?
Cash flow is a financial and accounting concept that encompasses three activities: operational activities, investment activities, and financing activities. It represents the net amount of cash a company acquires and sends within a specific period. Cash flow refers to the movement of cash into and out of the company.
The formula for calculating net cash flow is as follows:
Net Cash Flow = Cash flows derived from operational activities + Cash flows derived from investment activities + Cash flows derived from financing activities.
If the result of this equation indicates a positive net cash flow, it's considered a point of strength for the company. However, a negative result means that the company is facing a cash flow crisis or deficit, which can lead to insolvency if this persists to be the result over a prolonged period.
Causes of Cash Flow Crises in Startups
A cash flow crisis occurs when the cash outflow, such as costs and expenses, exceeds the cash inflow, such as profits and revenues, over a certain period.
There are 3 common reasons for cash flow crises in startups:
To prevent a cash flow crisis, startups must take proactive measures to safeguard their financial well-being.
Here are 4 key strategies to avoid cash flow crises in startups:
1- Regularly Monitor Cash Flow
To ensure your startup's financial well-being, it's essential to monitor cash flow regularly. This involves reviewing revenues, expenses, receipts, and accounts receivable at least monthly, if not weekly.
2- Improve Receivables Collection
Enhance your receivables collection process and cash flow by reviewing and refining customers’ payment terms. Automate invoicing and follow-ups as much as possible, using software that can generate recurring invoices for on-going services and subscriptions, such as Qoyod. Enable notifications that alert you about the status of the previous accounts receivable; the quicker you identify customers who don’t pay, the quicker you can solve your problems.
3- Negotiate Better Payment Terms with Suppliers
During a cash flow crisis, negotiating better payment terms with suppliers can alleviate financial pressure and maintain your startup's success. Having a mindset that focuses on problem solving is pivotal for the company’s financial well-being. Think of smart strategies to deal with suppliers, like negotiating for discounts in exchange for early payment (e.g., you agree to pay within 10 days for a 5-10% discount). Early payments help suppliers maintain positive cash flow, making them more amenable to offering discounts, which will help you reduce costs and expenses and overcome this crisis.
4- Reduce Unnecessary Costs and Expenses to Improve Cash Reserves
Cutting unnecessary costs is one of the most effective ways to improve your cash reserves during crises. Analyze your budget to identify the expenses you can reduce or eliminate.
Here are 5 suggestions to help you trim current costs:
In conclusion, diligent cash flow management and crisis prevention strategies can empower startups to overcome any cash flow deficits or crises as well as help them achieve long-term success and sustainability.