Startup killer - The true value of cash and cash flow for startups

As VC funding dries up in 2022 and 2023, and startups run out of cash, the pace of startup shutdowns and rapid business strategy changes accelerates.

During some weeks, down rounds are occurring faster than satisfying rounds, particularly for startups beyond Series A that are attempting to survive the perfect storm.

Cash flow issues are the primary cause of bankruptcies or downturns.

Those who were able and willing to pay CACs higher than LTVs to sustain growth are now making massive layoffs and begging for money at low valuations just to survive or pay wages.

Fresh capital from venture capitalists and bank loans is scarce and costly while it is nearly impossible to go public.

Some business models that worked when money was cheap are no longer viable for VCs.

The venture-backed startups are running out of funds and must make difficult decisions as their cash reserves diminish month after month.

Cash is the problem.

More than ever in 2023 and the immediate future.

The following article/essay covers the true value of cash and cash flow for startups and founders, three cash-related problems that cause founders to fail, how to grow your business without losing shares to investors by using other methods.

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Money and how you manage it are two of the most important aspects of running a successful business.

Even if your company is profitable and making money, that doesn't guarantee that it will continue to thrive and grow.

To get an accurate picture of a company's main financial needs, risks, and values, it takes hard work and a lot of knowledge.

If a company's owners do not understand basic accounting and finance, they are less likely to be able to run the company at its best.

Simply said, if you lack information or knowledge about a subject, you cannot make sound decisions about it.

There are numerous terms that owners, entrepreneurs, and founders must understand when it comes to the basics.

However, the famous expression "Cash is King" highlights the importance of cash in a business's overall fiscal health, where cash may make or destroy a company and should always be respected throughout the entire journey.

Putting cash at the centre of one's learning and focusing on acquiring knowledge about it would improve any business owner's and their venture's potential for success.

To understand a company's finances and effectively manage its money, an analysis must examine everything related to cash and how it moves. If you own a business or have started one and are in charge of its finances, this is the easiest way to do or learn how to do a basic financial analysis: "Where is the money and how does it move?"

As your company grows, the number of cash movements or transactions increases, as does the complexity of the analysis.

Above all, money is what keeps your business running, and failing to have accurate knowledge of it can kill your business.

Why do startups or any business need cash?

A startup or a new small business may need cash (money) for several reasons.

Cash is necessary to cover overhead costs like rent, utilities, salaries, and taxes.

As a result, a small business requires a consistent flow of cash or sufficient cash reserves to operate.

Cash is necessary to build a business.

With cash, a business can buy supplies or hire people to create, build, or produce products and services.

If a company doesn't have enough cash on hand, it might not be able to meet all of its financial obligations.

This could cause the company to fail, get fined, or have its reputation damaged.

Cash is also required for growth. For a new or small business to grow, it needs money to put more into its operations.

This could mean buying equipment or hiring people to make products or provide services, acquiring new customers through marketing and sales operations, or entering new markets.

Without cash, a small business may be unable to experiment with new ways to grow and improve.

Cash can be useful in difficult times. All businesses must use some of their cash to build up money reserves to help them get through unexpected situations, such as slow business times or economic downturns.

Cash is also a way to show investors that the business is financially stable and viable. A new startup or small business is more likely to be able to attract investors if it has a history of making money, having a profit margin, or having a strong positive cash flow.

Cash is also a way to gain access to some financial instruments that can be beneficial for your business under the right terms.

If a business doesn't have cash or isn't making cash, financial institutions will see it as risky and won't let it use loans or similar credit products.

A new startup or small business that has cash and is able to make payments on time on a consistent basis is more likely to have a better credit score, which can make it simpler for the business in the future to gain access to financing.

In general, a startup or small business needs to always have enough cash on hand for its finances to be in good shape.

This is because cash lets a company pay for operational expenses, invest in its growth (likely to get more customers or make better products), build savings for future needs, attract investors, and improve its credit score.

Just a quick note.

Working capital is the amount of available capital that a company can use for day-to-day operations in finance. And I'll frequently refer to "money or cash" as being required for day-to-day operations or any operational requirement listed above in this section that requires money to function. But I'm not going to use the term "working capital."

The reason for this is that "working capital" does not only imply cash in your bank account.

According to many sources, your net working capital reflects the amount of cash readily available to meet current expenses. When you look at the details, you will notice that different assets are involved in the calculation.

Net working capital = current assets - current liabilities

Working capital is calculated by considering short-term assets such as cash in your bank account, accounts receivable (money owed to you by customers), and inventory that you expect to convert into cash within 12 months.

Accounts receivable and inventory that can be converted to cash are not available today because they represent money that cannot be used immediately, distinguishing them from cash.

That is why, in order to keep the focus on money or cash, I will not use the term throughout the article. Later in the article, I'll go into more detail about the value of instantly accessible cash as well as the problems caused by accounts receivables or similar deferred revenues.

The ability of a company's founders to recognize the significance of cash (money) and cash flow can be the deciding factor in whether or not the company will be successful.

According to the leading startup and venture capital data and insight platform CBInsight, the most common reason for the failure of a startup is that ‘the company ran out of money.’

Founders typically focus on profit and loss when evaluating their business. Even investors make the same mistake from time to time.

Cash flow, on the other hand, should take priority. Cash flow reflects the entire movement of money over time. Money coming into the business, and money going out of the business.

Cash flow is vital because whether you're profitable or not, if you can't keep up with cash flow, everything will fall apart.

In the past ten years, I've been lucky to have the opportunity to build, help build, advise, or invest in more than fifty different technology startups.

Some wins have brought in more than $300 million in revenues with huge profits. Some of the losses were extremely costly and took years to occur; the latter-’years=time’-was more painful (one took $25 million while failing—a large sum of money).

Most of them just got stuck in what I call "deceleration mode" and turned into small, sometimes lifestyle, businesses.

Working with the founders of many large annual revenue-generating (over $60 million) or only funded but not revenue-generating startups, as well as many at the pre-product stage, I've discovered that founders frequently overlook three major finance or cash problems, and that ignoring even one of them puts the company at risk of failing.

I'll be writing another essay about this.

Problem number 1: Not understanding the value of cash, type of money/income/revenue, and importance of the timing of the cash or revenue clearly

Startup founders and business owners should know basic finance, accounting, and cash.

In the early stages of a company, the founder can learn the value of current or future cash by making and evaluating business plans on multiple fronts, such as hiring, building products or features, marketing and sales, fundraising, and investor relations, and asking and answering specific, detailed questions about these topics while keeping the company's financial situation in mind.

Based on the startup's most recent position changes, the best option is to assess the situation weekly and update these estimates once a week. The next best option is once a month.

This is called "forecasting," in short.

These questions can predict a company's future resource needs.

Why and how will cash be needed?

When is cash needed?

Is the amount certain?

Is this payment recurring? One-time payment?

As a founder, this may be the best vantage point for consolidating the true value of cash.

Value of timing for the value of cash

Founders can get a more accurate picture of a company's finances by taking into account the timing of income and expenses, as well as a few other factors.

You must consider this aspect of timing when forecasting and calculating how much money you'll need and when.

As a result of the chosen revenue method, the company's cash flow can benefit from careful consideration of the timing and collection of incoming amounts.

Revenue models, timing, and cash

The founders of a company that uses non-traditional methods to make money, like subscriptions, can find it difficult to do even the most basic accounting and financial calculations.

When a company's current cash flow or cash reserves aren't enough to fund its operations as desired, it can resort to debt financing, which includes borrowing money or using financial instruments like business loans or business credit cards with instalment payments to generate more available cash. The second option is fundraising by using your company’s equity, in which you trade your company's shares for cash with investors.

Revenue cycle predictability and cash requirements

Knowing how much it costs your company to acquire a customer and how much money they bring in within a guaranteed time frame makes things clearer and more predictable. Guaranteed for businesses means proven over time with more data.

In some other businesses with traditional revenue models, things can become complicated due to timing, and again, cash turnover can become a problem.

The more products or services the company sells, the more money it needs to operate and produce to grow.

Top accounting/financial terminology that any startup founder should know in order to minimize the risk of failure

Founders can learn more about the economics of their business and how to look at and manage cash, which is important for the success of the company, by becoming familiar with basic terms related to money, revenue, and cash, as well as major accounting and financial tables like the balance sheet, income statement, and cash flow statement.

Here are some fundamental and important terms:

Revenue

A company's revenue is the total amount of money it makes from the sale of its products and services over a given time period.

Cash

The term "cash" refers to money in a bank account that is ready for use. Cash is the most liquid asset that a business can have at its disposal.

Earnings

In accounting, earnings, also called "net income," are the amounts of money a company made or lost after all costs, depreciation, interest, taxes, and expenses were taken out of its total sales. This is the amount of money that a company is considered to have made.

Profit

The term "profit" refers to the amount of money that is left over after costs have been taken out of the money made over a certain period of time.

Assets

An asset is a resource that a company owns or has control over and that will help the business now and in the future. Cash, investments, accounts receivable, inventory, supplies, land, buildings, equipment, vehicles, and accounts payable are all examples of assets. In other words, it's an asset that a business has control over and can use to make money now and in the future.

Liabilities

Things that you owe or have borrowed are referred to as liabilities.

Cash Flow

The term "cash flow" is used to describe the overall net amount of money that comes into and leaves a company over a given period of time.

Cash Flow Statement

The inflow and outflow of a business's cash and cash equivalents are summed up in the cash flow statement.

The cash flow statement shows that one of the most important indicators of a company's overall financial health is how well it can make money and manage the money it already has.

Knowing how to read and interpret a cash flow statement is a valuable skill for anyone in a financial role, including founders, vice presidents, chief financial officers, managers, directors, and investors.

The goal of a cash flow statement is to show in detail what happened to a business's cash during an accounting period, which can be the most important financial information for the business's owners.

That's why I'll talk more about cash flow in the rest of the article.

Balance Sheet

A balance sheet is a type of financial statement that lists an organization's assets and debts at a certain point in time.

Income Statement

The income statement is one of a company's fundamental financial statements that shows its profit and loss over time.

Compare the following three key business statements and sheets:

Balance sheets show a company's assets and debts at a certain point in time.

Income statements show how much money a business made and how much it spent over a certain time period.

Cash flow statements show how money moves in and out of a business over a period of time.

Accounts Payable

Money owed to vendors for goods or services bought is called "accounts payable."

Accounts Receivable

Accounts receivable are the amounts of money that customers owe a business for goods or services they have used but haven't yet paid for.

Accrued Revenue

Accrued revenue is money that has been made by selling a good or providing a service, but no cash has been given for it yet.

The main difference between an accrued revenue asset and an accounts receivable is whether or not the customer has already been billed.

Deferred Revenue

Deferred revenue is money that comes in for services or goods that will be delivered later.

Gross Revenue

Gross revenue is the total amount of sales for a given period before any deductions are made.

Liquid Asset

A liquid asset is cash on hand or any other asset that is easy to turn into cash.

Net Income

The term "net income" is used to describe the money left over after deducting expenses, tax payments, and other expenses.

Gross Margin

Taking total sales and subtracting the cost of goods sold (COGS) yields the gross margin.

Operating Expense

The term "operating expense"(OPEX) refers to the costs incurred by a business as a result of its management, marketing, and operational activities.

Debt

Debt is how much you owe for money you borrowed.

Equity

When assets are subtracted from liabilities, the result is equity.

Working Capital

Working capital is the amount of available capital that a company can use for day-to-day operations in finance.

Working capital is figured out by taking into account short-term assets like cash in your bank account, money owed to you by customers, and inventory that you expect to turn into cash within a year.

Problem number 2: Overspending in general, being distracted by cash in a bank account, or working on unnecessary overspending ideas with no return while ignoring the company's unit economics and growth

Startup founders and business owners must maintain low burn rates through expense controls because the costs of building a revenue-generating and profitable business are unpredictable.

Problem number 3: Lack of focus on revenue, sales, and financial goals

The third major cash or finance issue that founders often overlook but that can make a company fail is a lack of focus on revenue and financial goals.

Startups often take too long to create a great product.

Revenue generation is a business's main objective. Its maintenance and growth can follow.

Understanding Cash Flow: what does it mean for a company?

During my experience with several companies where I am not only a shareholder but also a member of the team responsible for the company's success, I have learned two important lessons about finance.

First, regardless of whether a company is doing well or poorly financially, looking at balance sheets and income statements does not provide any quality information that reflects a company's true financial health, but rather is deceptive, whereas cash flow is the top statement that can show at least some real insights into that.

Second, because their financials aren't ready and are constantly changing, investing in new businesses or startup companies at any valuation will always reflect the optimist assumptions made by optimist investors who make a living by betting on hundreds of companies that don't have and can't have clear balance sheets and cash flow statements due to their stages and hoping their bets pay off. Because of this optimism, only 5% of the venture capitalists who invest in these startups survive and do not fail.

Even though success rates are extremely low, during fund-raising meetings, many investors act as if they are extremely successful at what they do. If you, as a founder, ask the right questions and demand exact numbers, you will discover that they are failing. The amusing fact is that some of them may be unaware that they are failing.

Going back to my topic, cash flow is the amount of money that comes into and goes out of a business, project, or financial instrument.

In general, it is defined as the net amount of cash and cash equivalents coming into and leaving the company.

The cash flow statement is the best way to keep an eye on the runway because it is the simplest statement that shows how much money comes in and how much money goes out.

A cash flow statement that shows a positive number indicates that the company is bringing in more money than it is spending, while a cash flow statement that shows a negative number indicates that the company is spending more money than it is bringing in.

Understanding cash flow, even at a basic level, and how to read and act on it can make planning much easier for founders while they concentrate on the economics of their current or future business and its cash management, which is important for the success of the company.

Cash flow can be broken down into three categories: operating, financing, and investing, all of which can help you better understand where your money is going and how it's being used.

These categories help anyone evaluate cash flow through the use of a variety of metrics, including the following:

Operating cash flow: It shows how much money the company makes or loses from day-to-day operations such as product sales or employee wages.

Investing cash flow: This demonstrates how much money the business spends or earns from its investments in fixed assets like property and equipment.

Financing cash flow: Outgoing and incoming cash from debt financing, equity financing, and other sources are detailed here.

Managing cash flow is important for businesses of all sizes, as it can impact a company's ability to operate, pay bills, make investments, and achieve its revenue goals.

One final thing to remember about what cash flow means for a company is that when looking at cash flow or other financial statements, keep in mind that if the runway is less than 18 months, it's time to act and seek financing as a founder.

Why is cash flow critical to the success of businesses?

Businesses need to pay close attention to their cash flow because it is a direct reflection of the company's overall financial health and stability.

For a business to stay in the game, the money that comes in (is earned) should always be more than the money that goes out (is spent).

For some businesses, this may pay off in the long run. If not, expenses can be covered temporarily with cash reserves, investment funds, or bank loans or credits. Most likely, the company's main goal will be to make money and keep making more of it. Still, if they are growing, they can continue to spend more than they earn because this is the recipe for business growth.

Because cash flow is the most important measure of a company's performance, banks and other financial institutions mostly use it to determine a credit score.

A company must have a positive cash flow in order to meet its financial obligations, such as paying wages or taxes, investing in its business, and meeting the financial goals it has set for itself. If not, there will be problems.

On the other hand, if a company has negative cash flow, it indicates that it is spending more cash than it is generating, which can be a danger sign.

Knowing the company's current situation and future plans makes it possible to figure out how healthy the company really is by looking at its cash flow statement.

This can be demonstrated in two ways: a negative cash flow statement can indicate potential financial trouble, which if not corrected, could lead to the company filing for bankruptcy, or it can indicate a company's investment for growth, where spending more than it earns is unquestionably required to grow. Where a company fails versus where it succeeds. The true meaning of this statement can only be understood from extensive and detailed knowledge of this particular business and industry.

For new businesses and startups, it's important to remember that the goal should be fast growth, not a lower burn rate. To put it another way, as a new business, you'll have to spend money until you start making money, and then you'll have to keep spending money to keep making more and more money by getting new customers.

During an expansion or growth phase, a company's cash flow may look negative if it is investing in activities that will bring in future profits that are expected to be higher than the costs of expansion or growth.

This negative look on cash flow statements can happen from time to time or for a long time while building or growing the business. The negativity is intentional because these losses are the result of ongoing investment in the business for future earnings.

As a startup founder, you must understand that investors give you money so that you can spend it on growing your business, not just sit on it.

Of course, returns on investment are critical, especially when expanding your business.

A key point to remember here is that if you want to make more money, you must be willing to spend more when you receive a good return on your investment.

I have realized that this is not only a simple recipe, but it is also an option for founders who simply want to grow continuously.

Some founders simply choose to go slower as they become satisfied with the current size of the company and prefer to stay in their comfort zone after the initial growth because it is less stressful. I personally knew a few founders who knowingly dragged their companies into what I call "deceleration mode," and I was an unlucky shareholder in a few of them.

A common thing about these founders is that they missed the chance to grow their business more because they were too happy with how it was going and how much money it was making, which caused them to lose focus. This lack of focus was the second problem that was mentioned earlier.

In addition to being a measure of financial health, cash flow is also important because it can impact a company's ability to take advantage of new opportunities, such as expanding into new markets or launching new products.

It can also be a big part of a company's ability to get and keep investors, since they usually want to see a history of positive cash flow or the ability to make positive cash flow if they need to.

How can you ensure that your business maintains a healthy cash flow?

A healthy cash flow refers to a situation where a business is generating more cash than it is consuming.

This is usually a good sign because it means the business is financially stable and able to pay its bills, invest in its business operations, and reach its growth or financial goals.

There are several steps that a founder or owner can take to establish and maintain a healthy cash flow.

One of these steps, my favorite and possibly the most important, is strong sales and revenue.

It is my favourite approach because a company with good sales growth is likely to have more cash coming in, which can help to improve many elements of its operations.

A consistent and large cash flow will also allow you to fix things along the way if something isn't working properly or if any aspect of operations needs to be optimized to improve business.

Being able to make changes to fix or improve things shows flexibility, which is always advantageous. Cash allows you to do this in business.

As a result, focusing on sales growth and never losing sight of it can help a company stay on track.

This can be accomplished by entering new markets, introducing new products or services, introducing new features, or improving or optimizing marketing and sales strategies. Hiring people who can do this and keeping them happy should, of course, be prioritized.

Overall, a company's long-term success depends on its ability to generate a steady stream of cash flow, which is a good sign of the company's financial health and stability.

Another important factor of maintaining a healthy cash flow is good financial management practices.

Accounting skills are required to keep accurate financial records that show exactly how much money comes in and goes out over a given time period. Only in this manner will owners and other responsible people be able to properly evaluate the past or current situation and forecast future cash requirements.

Things will fall apart if the financial records are incorrect or missing any data because decisions will be made based on misjudgements.

Another method for maintaining a healthy cash flow is to monitor and track it on a regular basis, as mentioned several times throughout the article.

Without complete information, anyone can make decisions that will lead to failure.

That's why doing these regular checks will help you find problems or areas you need to focus on as soon as possible.

Monthly, even weekly, inspections would be extremely beneficial if the founder wishes to stay on top of any potential changes in the need for cash and its timing in the near future.

Another way to keep a healthy cash flow is to keep costs under control and look for ways to save money.

Low costs, a low burn rate (one of my favorites), and efficient operations can be other factors.

A business can improve its cash flow by using less cash. It can do this by streamlining its operations and cutting costs.

Keeping costs in check and looking for ways to save money can mean negotiating better terms with suppliers, finding more cost-effective suppliers, or cutting expenses that aren't necessary to provide a healthier cash flow.

When assessing potential cost cuts, consider them as more than just money saved. Consider how to turn these savings into an improvement by allocating the money saved by cutting a cost or spending to another point of operation that can increase business output.

Companies of all sizes need to change the way they spend so that all costs are justified by how much they are needed to keep the business running normally. Creating or adopting a spending culture based on this can help.

Another way for a business to maintain a healthy cash flow is to improve the time periods for collecting payments from customers.

Two different types of revenue models, one with recurring payments (subscriptions) and the other with one-time purchases (traditional sales), were used to show how slow or late payments from customers could affect cash flow in a negative way.

Improving collections in any possible way can make a huge difference in cash flow. The faster you receive money from a customer or user, the better your cash flow.

When customers pay slowly and in small amounts, it can be hard for a business to keep enough cash on hand, and it becomes necessary and urgent to get financing. This was covered in the "problem number one" section.

Consistent and sufficient cash flow from operations to pay expenses and invest more can allow a company to finance its operations without the need for additional financing.

In traditional revenue models, setting up clear payment terms and following up on overdue payments can help create a healthy cash flow.

Businesses with subscription or recurring revenue models can improve their cash flow by giving customers the option to pay yearly or quarterly and offering discounts that customers will like.

The last method of maintaining a healthy cash flow is to use financing options to help the company's cash flow. Banks and finance companies can give businesses loans or credit cards with low interest rates, which can be very helpful when the business needs more cash.

Some of these loans and credit cards, such as those offered by the Fintech company Debite in the UK, can provide you with money at no or low interest rates, as well as payment plans with instalments to help your business' cash flow.

Rather than spending your own money, you can spend the money of the bank for free or at a low cost. Who said banks are evil?

Finally, working capital, or the difference between a company's current assets and current liabilities, can be used to assess a company's cash flow health.

In order to boost its cash flow, a company needs to have more current assets than current liabilities, which it can achieve with a positive working capital.

Some of these assets are not liquid cash, but they can be quickly converted to cash. Which may be worthy of consideration.

Growing sales, good accounting, constant monitoring, cost savings, improved collection, and taking advantage of financing options are all required to establish and maintain a healthy cash flow.

Depending on the type of business and how the company is set up, none of the above strategies will change, while different approaches may be needed at each.

Please read the second part of the article "Fundraising is more costly for startups than business loans&credit cards when the timing is right" to understand how to benefit from business loans and credit cards, why to not fundraise from VCs, sell VCs or investors your shares from the highest valuation, and realize that I actually don't like investors.