Typical cash flow traps in startups

Cash flow in startups – learn about the most common traps that lurk for young companies when creating a cash flow statement.

Finances in a startup

The founders know what their product is and they know who it is for. They also usually know where they want to be in a few years. And here comes the question: how much money is needed to achieve these goals? Anyone thinking about their own company faces this question. It’s commonly called a business plan, but it’s really a strategic plan dressed up in numbers and presented on a timeline. The more thorough the planning, the greater the chances of success of the venture.

Financial reporting – that is, standardized documents showing the condition of the company are not only documents about past events, they also show plans for the future. The balance sheet, income statement and cash flow statement – or so-called cashflow – are financial statements without which it is impossible to run a business. Without short- and long-term forecasting, you can’t grow your business and attract investors.

Cash an important resource for any company. Regardless of your business profile, mistakes in cash flow planning can shorten the time your company has before it runs out of money. That’s why it’s so important for startup founders and finance leaders to build the most accurate cash flow forecast possible and get an accurate picture of how growth plans will affect cash.

Cash flow forecast – what is it?

A cash flow forecast is a projection of how much money will be left over after taking into account income and expenses during a given period. Cash flow shows an estimate of future bank balances based on money coming in and going out of your business.

In addition to accounts payable and accounts receivable, the cash flow forecast also includes items such as revenue, payroll and other expenses. All of this information makes cash flow a key tool for understanding how changes in strategic plans will affect day-to-day operations.

At the most basic level, the purpose of a cash flow forecast is to make sure you know whether you have the necessary amount of cash to keep your business operating. But a great forecast is more than just confirming that you have enough working capital to pay your bills and employees. It should also be a tool for thinking through strategic challenges, such as finding ways to extend operations and deciding when to raise the next round of financing (and how much you need to raise).

Typowe puƂapki cash flow

Start-up companies fall into the typical pitfalls associated with various forecasts, including cash flow forecasts. The reality is that cash flow planning is not easy under any circumstances – even if finance is your specialty. That’s why lack of cash is one of the main reasons startups fail. To stay in control of your cash flow, avoid the following pitfalls.

Trap No. 1: You only plan for the ideal scenario

Startup leaders who forecast cash flow on their own using an Excel template or other accounting software often stop at ideal scenarios for payables and receivables. Assuming that cash inflows and outflows will occur under ideal circumstances can lead to problems with budgeting and strategic business plan planning.

Your cash flow forecast needs to take into account more nuances than the ideal scenario covers. What if you assume that payments can be spread over 12 months, but in reality you have to pay for twelve months up front? What if one of your customers gets into trouble and can’t pay an invoice? These would be serious obstacles to short-term cash flow management that could thwart strategic plans.

It is difficult to create a cash flow forecast that takes into account all the nuances and volatility that can affect bank balances. However, deep insight into a wide range of potential scenarios is critical to a startup’s success.

Trap No. 2: Your cash flow forecast is separate from your financial models

One of the reasons startups experience cash shortfalls is that their forecasts and cash flow projections don’t line up with hiring plans, spending projections, sales rep quota plans and other financial models to help run the company. This happens when the financial assumptions made in the model do not match the reality of changes in the bank account.

You can build your financial model on the assumption that 100% of your customers will pay you every month. But in reality, you may end up negotiating different terms depending on the customer. What happens if 80% of your customers pay monthly, 10% pay annually, and 10% pay upfront? If you adjust your cash flow forecast without updating your financial model, you could end up with blind spots in your strategic plans.

Trap No. 3: You transfer financial handling to an external entity.

Even if you don’t create a cash flow forecast yourself, you should be able to project how your strategic plans will affect cash flow. Flexibility in conducting “what if” analyses is key.

What if all your customers started paying in advance? What if a few of your customers are late in paying their invoices? What if new suppliers expect payment within 60 or 90 days? If someone else is managing your cash flow plans, and you don’t fully understand the forecasts, you could make decisions that put your business at risk.

How to avoid traps with cashflow analysis?

It is a good idea to have an accountant or finance specialist to prepare cash flow projections. However, if you want to keep control of your cash flow, you need to be part of the process.

There are quite a few different tools for creating cash flow forecasts, but there are hooks here, too. Most often, the reports that are a component of ERP programs give a running picture based on the invoices entered into the system according to due dates, and you need forecasts. For this purpose, we suggest making a report using MS Excel.

Each item is detailed in a dedicated sheet and the view is a collection of individual information. The document is updated once a week and designed for the next 6-12 months. It includes events about which we are certain and those that are very likely. There are planned expenses based on past events. But since we have signed long-term contracts, hired employees and already know the values of our future income and expenses, there is nothing to prevent us from entering them in the table and making sure that we have enough funds for the next few or even several months.

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Magda Nurkowska
Head of Finance & Administration
At Innovatika, she is responsible for financial management and administration. She ensures that the Board of Directors is provided with practical and complete financial data needed for efficient management of the company. She oversees processes and is responsible for strategy implementation.

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