Whether you’re bootstrapping or have raised funding, cash flow management is essential for any tech startup. Cash flow is the lifeblood of your business and managing it properly can mean the difference between thriving and struggling to stay afloat. Even though everyone understands the importance of cash management, when I ask founders “what is your cash life” or “what is your cash burn”, I’m often met with blank faces. I get it – managing cash in a startup is hard and it’s not glamourous. But just like your product roadmap or go-to-market strategy, cash management requires careful planning and attention.
In this article we’ll cover some of the tips and strategies to manage your cash.
Understand Where Your Cash is Going
It’s hard to manage your cash if you don’t know how it is being spent. Getting a clear view of your cash flow starts with accurate financial statements that you can review monthly. This is where having good bookkeeping is critical – it ensures that transactions are being properly classified, accurately entered, and done in a timely manner. An emphasis needs to be placed on having good bookkeeping as just doing bookkeeping for the sake of checking it off your to-do list will not give you the transparency you need.
Here’s a case in point. One company we started working with seemed to have unexpectedly low gross margins for a SaaS business. After digging into their financials, we found that their implementation services were underpriced and there were many costs incorrectly classified as Cost of Service, which was dragging down their overall margins. The problem was that their financial statements weren’t detailed enough to reveal this. By breaking down revenue and expense lines in their accounting system, we gave them the monthly visibility they needed to understand and correct the issue.
Founders should review their financials monthly (or quarterly for very early-stage startups) to see where their money is going and identify opportunities to cut costs or adjust pricing. However, many early-stage companies “manage” cash by simply checking their bank balance, which doesn’t give you the complete picture. It only tells you the end result, not the story of how you got there.
Prepare a Budget
Once you have reliable financial statements, it’s time to create a budget. I suggest preparing a 2-to 3-year budget to understand how long your current cash reserves will last and estimate how much additional funding you’ll need to meet your business objectives. This understanding will give you the data you need to make critical decisions about the future of the company such as product development, hiring, sales, etc. After all, how can you decide how many developers or salespeople to hire without knowing what it does to your cash life. Making business decisions without this insight is akin to going on a long road trip without access to any maps or directions on how to get there – you may get there eventually but it’ll take you a lot longer than you had planned.
Here are some tips for creating a budget:
- Keep Realistic Sales Targets: Don’t overestimate your revenue growth. Be realistic about what you can achieve based on past trends and available resources. It’s important to also ensure that you take into consideration the people and resources you’ll need to drive new revenue. Founder led sales may not be scalable so you will likely need people to drive revenue growth.
- Create a Hiring Plan: Determine how many people you’ll need to meet your objectives, and consider the trade-offs between cash management, company goals, and new hires.
- Refer to Market Data for Salaries: Ensure projected salaries for new hires (and your existing team) are reasonable by comparing them with market data.
- Scale Expenses: Make sure your expenses (COGS and Opex) scale with revenue and headcount as needed. It’s fine to build in some economies of scale.
- Include a Balance Sheet and Cash Flow Statement: Many early-stage companies will commonly only create income statement (revenue and expenses) budgets. The problem is that in most instances the income statement alone will not give you an accurate picture of your cash burn and cash life as it doesn’t capture differences in the timing of collections and payment. The cash impact of items such as accounts receivable, accounts payable, loans, and prepaids are not normally properly captured in an income statement. For example, if you are forecasting revenue of $200,000 in January but customers take an average of 60 days to pay you, the cash will not be received until March. You need a way to properly reflect when the cash will actually be received and the most common way to do that is to include a balance sheet and cash flow statement in your forecast.
- Update the Budget Regularly: Things tend to move very quickly in startup and scaleup companies. It is important to reflect changes in your budget to understand the impact on cash. Normally, revisiting and revising the forecast quarterly should suffice for most early-stage companies.
Review your Expenses Regularly
Startups and scaleups often can’t control the timing or amount of revenue growth, but they can directly control expenses. A regular review of your operating expenses, at least quarterly, can help identify areas where you can cut costs and improve your cash flow.
Here are some key tips on how to conduct a comprehensive expense review:
- Perform a Budget versus Actual Review: Compare your budgeted expenses with actual spending to identify discrepancies. This analysis can reveal areas where you’re overspending or where you’re not allocating enough resources.
- Review your Salary Expenses: Salaries normally represent 60%-80% of an early stage company’s costs. Ensure that you’re reviewing the team composition regularly to ensure that it still meets your company’s objectives – especially if there has been a shift in strategy.
- Audit Software Subscriptions: Software subscriptions are a common source of hidden costs. Review your subscriptions to identify tools or services you’re no longer using, as well as inactive user accounts. Additionally, check for overlapping functionalities between different software products—consolidating can save you money.
- Analyze Credit Card Spending: Credit card expenses often go unnoticed until they become a significant drain on cash flow. Examine your company’s credit card statements to find unnecessary or excessive spending. Look for expenses related to travel, meals, or other discretionary items where you can reduce costs.
- Monitor your Hosting Costs: As your company grows, hosting costs can climb faster than revenue. Review your current hosting plan to identify areas of over-provisioning or unnecessary services. Talk to your hosting provider about cost-effective options. By managing hosting costs, you can ensure they stay in proportion to your revenue and don’t cut into your profits.
Manage your Accounts Receivable
Many early-stage companies struggle with timely invoicing and collecting receivables, which can significantly strain cash flow. This can put a significant strain on a company’s cash as it can extend the time from closing a sale to cash collection by weeks (if not months). To avoid this, establish a process for invoicing customers as soon as possible and collecting as invoices come due. The collection reminders can begin with automated emails from your accounting system and then slowly escalate as the invoices remain overdue.
Effective cash flow management is critical for tech startups. By regularly reviewing your expenses, preparing budgets, and managing working capital, you’ll be better equipped to navigate the uncertainties of startup life and build a sustainable business. After all, cash flow isn’t just about staying afloat—it’s about creating the flexibility and stability your startup needs to thrive and grow. With a solid cash management plan in place, you’ll be able to focus on what really matters: building great products and serving your customers.
If you need expert assistance with bookkeeping, fractional CFO services, or fractional HR services to help you manage your company and its cash flow, we’re here to help. Contact us to learn how we can support your startup’s financial journey. With the right guidance, you can keep your business on the path to success.