“You know that 29% of the reasons why startup failed was caused by running out of cash. But do you know why that is the case?”
Since a small business and startup tend to have limited resources, the key factors they need to consider is how to manage time and money, so their business can stay afloat. Despite the hard work and dedication, sometimes the forces are out of your control. Based on CBS Insight data, 29% of the reasons why startup failed was caused by running out of cash, followed after the top factor: 42% of business have a service/product that is unfit to the market which directly affects finance and abilities business to survive.
How do small business avoid these pitfalls and stay healthy financially? These are five basic finance area in small business for you to keep an eye. Keep in mind that these five area is a big area on its own, and not to be confused with financial statements.
1. Cash Flow
First thing first: Cash flow is the lifeblood of your business that keeps your business running. Putting it in the easiest way possible: Cash flow is your business ability to sustain itself over period of time. Positive cashflow means you are making a sustainable business, and negative cash flow means you are either losing your business or you are in debt.
Positive cash flow is driven by two things: Planning and organizing your finance. To avoid debt, you need to have a proper cash flow. You can check whether you are going positive or negative by your Cash Flow Statement. Your cash flow statement shows how much money going in and out of your business for a set time period (usually per month). It gives you warning signs to help avoid future financial trouble.
2. Pending Receivables/Debt
Pending receivables are money you have earned but it’s just not there yet, floating between cash outflow and inflow. You definitely are making sales to have pending receivables and it’s a good thing. But receivables can also doubles as a bad debt. You need extra efforts to collect your debts such as maintaining their records, calling them up, and in some case, put a very extra effort to claim it.
Bad and doubtful debts arise when some of your receivables are left unchecked or become uncollectible. It could be a hindrance to your business or even worse, eating your revenue or blocking you to have debt when you really need one. It is important to transform pending receivables into cash flow. Here’s some trick to avoid a bad debt:
Clear payment terms
Give your client a clear payment time-frame. Best practices would be 30/60/90 days (adjust to your needs). This would be the first foundation of your cash-flow and financial expectations. Be very clear about the payment methods you’ll go with, as detailed as you can be. Some of the payment methods have fees associated that either you or the client pays.
Grant rollover credit
Grant specific amount of credit limit to each of your clients. These limit can start small and gradually up as you build your relationship with them. It’s important to set out these limit clearly from the beginning in your work/service contract in a way that balances client convenience and your cash flow.
Offer an incentive for early payments
Think about giving your clients an incentive to make their payments early, such as a discount, reduced interest, or free shipping. This way, everybody wins: your customer is rewarded for making an early payment, and you get your inflow of cash sooner, which is great for your bottom line and increases the likelihood of gaining a repeat customer.
3. Profit/Growth Rate
Profit can be defined simply:
Revenue - Expense = Profit.
Generating profit is probably most important objective on the business, as profit measures success on a for-profit business. To increase profits you must raise revenues, lower expenses, or both. A profit growth rate must be keep in check as growing too fast is as deadly as having no profit.
Why? Because Growing too fast might burn you, depends on your ability to scale up. Let me give you an example: Friend of my friend was knee-deep in offline learning academy market few years ago. These are the times when online learning has not reached today’s popularity. He was managing 10+ instructors and handling just one location. Business boomed and he got 400%~ growth rate (he grew out his business by four times) in just 6 months . His first instinct? Add business branch, more locations.
He created more than 8 locations in a year, before shutting down his business the next year. What happened? He grew too fast and not carefully enough think of his business threats (that is online learning at that time).
Profit is good, and growth rate is good. But just like anything else in this world, having too much of one thing might not be a good thing.
4. Expenses/Burn Rate
Simply said, cash burn rate are how fast are you burning through your cash reserves. Since profit is revenue minus expenses, we must explore the idea of matching expenses and revenues together. The high expense to revenue ratio can create an illusion of profit. High expense is dangerous because you will always need a large amount of capital in order to keeps your business run. To determine your profit, you must first identify all expenses for the period under study.
Know your expenses well
One business expenses will be different from another, but there are some common expenses for small business and startup:
- Research expenses
- Equipment & office space
- Fees & Utilities
- Payroll & other incentives
- Sales & Marketing
Calculate Your Burn Rates
Cash burn rate or negative cash flow is the pace of how a company spends money. It’s often calculated by month and spends overhead expenses. A company’s gross burn is the total amount it’s spending on operational expenses each month (with the absence of positive cash flow.). To calculate your burn rates, follow these steps:
- Find the difference between the starting and the ending cash balance for the period.
- Divide the total by the number of months in the selected period.
- You now have the cash burn rate.
$20.000 (Starting Balance) - $11.000 (Ending Balance) = $9.000 (Difference)
Reduce Your Burn Rate
You need to increase incoming cash and decrease your out-coming cash, or both. To reduce your burn rate you need to first know your fixed vs variables cost. Fixed cost are costs that you can’t avoid to pay and are essential to your business operational.
Variable cost in other hand, are costs that scale up and down depends on your business activity. Few possible scenario of variable costs are:
- Marketing & Advertisement
- Transportation and meeting expensesAnother way to reduce your burn rate is to operates a hybrid team of online vs offline people. Combine it with proper balance of outsourcing and freelance work and you could reduce your burn rate when your business are not on the top of financial position.
5. Scaling Capabilities
“Managing the operations by hands-on involvement of founders will eventually limit growth”
Small businesses realize that the road to success depends on one’s ability to scale rather than merely “grow.” Scalability refers to your business’s capability to perform well under an increased workload or an expanded scope. Inability to scale up well when the market demands, will often result either in declining profits or in a loss of profit as a result of your business getting surpassed by competitors that could better provide value to the customers.
Evaluate Financing to Expansion
How do you go from $50 million to $500 million? How do you execute the plan? The answer is, You need funding or a reserved cash. There are several ways to secure fund for for small business:
- Traditional term loans
- Short-term loans
- Business lines of credit
- SBA loans
- Kickstarter and crowdfunding
- Joint ventures with established players
- Creating new predictable revenue streams
If the conditions above are met, chances are your business model is scaling properly and efficiently. With all the financial information that we have shared, you can now begin to pay extra attention to ensure the finances of your small business are properly examined.
Rock Paper Scissors is a Digital Business Architect. We help you create your own digital startup by turning your vision into a valid, clear milestone. We cover digital product planning, managed operation, and product launch. Find out more.