Common Cash Flow Mistakes That Startups Commit

Prabhat Nigam

10 Sep, 2022

After analysing the causes of failure of start-ups across the world, the major cause of their failure has turned out to be improper cash flow management. This points to the fact that generating a healthy cash flow is essential for the survival of an early-age start-up which requires proper planning and a strong operational strategy. Conversely, inexperience in cash flow management can be fatal for the existence of a budding start-up.  

This piece of writing discusses the meaning of cash flow and common cash flow mistakes that start-ups commit.

What is cash flow?

In simple words, cash flow is the amount of money that comes in and goes out of a business. It refers to the net balance of the incoming and outgoing cash in a business at a specific point in time. Cash flow can be both positive and negative. Positive cash flow means that a business has more money coming into the business than going out. Vice versa, negative cash flow means that a company has less money coming into the business than going out.

What are the common cash flow mistakes that are committed by start-ups?   

Following are the common mistakes that are committed by start-ups:

• Billing arrears: one of the common mistakes committed by the early-age start-ups is billing their clients in arrears only instead of asking for full or at least partial payment upfront. Most of the vendors either declare bankruptcy^[1] or pay slowly or don’t pay at all at the time of payment. This can take your business to a slow death. Therefore, it is advisable to ask for full payment upfront or ask for partial payments before offering your services.    

• Strongly negotiate on payment cycles: Most start-ups feel that because they are starting afresh, they do not have the leverage over vendors to negotiate favourable terms, and they accept what vendors dictate, such as upfront payment, 50% payment or payment within 15 days. The common cash flow mistake committed by start-ups here is that they do not take into account their payment cycle, the time within which they will get their money from buyers. In such cases, the start-ups must first decide the time of receiving their payment and accordingly negotiate with their vendors the time of payment and spread out such payment. For instance, if the time of receiving the payment is 30 days, then the start-up must negotiate for 45 days payment cycle.     

• Failing to account payment timing: Another common cash flow mistake is the failure to account payment cycles in the payment received. Most start-ups fall into trouble for not receiving timely payments from the vendors and constantly making outgoing sales which creates problems related to cash crunch. To cover this gap, the start-up has to approach lenders to take loans to fill this gap. The start-ups should always incorporate the late payment within their fees and reward the vendors with a discount for making timely payments.    

• Failure to count convertible notes as debt: a common cash flow mistake that most start-ups commit is that while raising funding, they fail to count convertible notes as company debt. The investors have the right to demand repayment once the maturity date arrives. Though it is uncommon for the investors to demand convertible notes on maturity, this can be used as a tool they can use as leverage in future negotiations with the founders.       

• Making heavy investments too early: In the quest to take their businesses to the masses, start-ups invest way too much in marketing their product at the early stages of business development than focussing on consolidating their business and maintaining cash flows. This causes the problem of a cash crunch, and the business starts bleeding. Therefore, it is advised that start-ups should first consolidate their business first, start generating positive cash flows for the business and accordingly and gradually start investing. This also helps in identifying wasteful investments and keeps a check on expenditures made on such investments. 

• Raising investment without proof of concept: a common practice that has been in vogue is that founders of start-ups get caught in the trap of intermediaries who assure them to arrange a meeting with VCs to garner investments. For such an arrangement, the intermediaries demand 2 per cent and the founders, in order to raise investment, dilute way more equity than they need to. Therefore it is advised that the start-ups should approach investors with a proof of concept first instead of directly approaching for investments. This way, they can not only negotiate from a stronger footing but also secure a fair deal.   

Conclusion 

A lot has been discussed about the common cash flow mistakes committed by start-ups, but the list is not at all comprehensive. Some of the lesser known but common cash flow mistakes include ignoring to critically look at every expense made by the firm without questioning how that expense justifies itself, reliance on the bank balance to meet the cash flow needs, and not setting aside a contingency fund. To deal with such mistakes, solution of such these things should be properly integrated into their internal controls. Failure to manage cash flow can prove to be fatal not just for the growth but the survival of the business.  

Read our Article: Cash Flow Forecasting in Financial Model