Cash flow is probably the most important financial metric for any startup, and the ability to predict when your company will run out of cash, even if it is 12 months into the future, is incredibly important, especially for startups that are looking to raise capital from investors or lenders. There are a handful of factors that will impact your cash flow, and putting them altogether in a financial model is necessary for any business to determine the timing and amount of capital that is needed. The primary factors that impact your cash flow include:
- Accounts Payable Terms – How many days can you wait to pay your bills?
- Accounts Receivable Terms – How long does it take you to collect payment for your sales?
- Bad Debt Expense – What percentage of your customers just won’t pay?
- Seasonality of the Business – Some businesses (lawn care or snow removal) make 90% of their revenue in a 3 month period of time
- Annual Expenses – There are certain annual expenses that can surprise you if you don’t plan well (property tax, insurance, payroll taxes)
Now the challenge is to put all these factors together to predict the exact month you will need an infusion of cash for the business. I am going to use our ProjectionHub forecasting tool to demonstrate how this process should work:
1. Project Sales
So as you can see here we are projecting that you typically take 25 days to pay your bills, and from above we know that your customers take 45 days to pay you, so you will have some inherent cash flow challenges.
3. One Time Expenses
Now we look at those pesky one time annual expenses that tend to creep up on you. You think you are doing well because you made a profit the first 4 months of the year, but you forgot that in month 5 you have to pay $5,000 in property taxes that will eat away all of your profits to date. So with ProjectionHub you can enter in those one time expenses ahead of time to help you predict when you will run out of cash. See how we enter in our monthly and 1 time expenses below:
You can see a one time expense on both the insurance and property tax rows.
4. Bad Debt Expenses
It is a fact of life that some customers just won’t pay. You should come up with some percentage of sales that you don’t expect to receive payment for. Maybe that amount is 5%. I entered a percentage for miscellaneous expenses which includes bad debt expense and other unexpected expenses.
Now that we have entered in all of our basic sales and expense data into ProjectionHub, lets look at the resulting Excel file that the tool produces, and check our cash flow statement to see if we run out of cash.
Awesome Startup Runs Out of Cash in Month 2
So without a capital infusion our startup is already in the red in month 2, and it only gets worse from there as you can see below:
Now we need to think of plan B. What if we could get a small loan to start the business to help with cash flow. Let’s enter a small $15,000 business loan at 6% for 24 months starting in month 1.
Now with this infusion of cash let’s go back and check how our cash balance is doing on the spreadsheet that ProjectionHub produces for us.
You can see that we stay cash flow positive through month 7 now that we have this loan, but maybe you would like to expand your vision for the company a bit. You are going to need to quit your day job to work on this full time, and you are going to need a salary to pay your personal expenses. Let’s start you out with a meager $3,000 monthly salary starting in month 6.
Now there is a small problem because if you look at month 7 above you have a cash balance of $5,896, but we just added $6,000 worth of salary expenses for month 6 and 7, so you are going to end up in the red again in month 7 if you don’t raise more capital. This time let’s think about finding an investor. Let’s assume you are planning ahead in month 3 and see that you are going to run out of cash if you start taking a salary, so you call your rich uncle and convince him to invest $15,000 in month 5.
Finally, let’s look how this investment sets you up going forward.
Congratulations! Look at the influx of cash between month 5 and month 6. You are going to survive, and your startup won’t run out of cash. Now why don’t you take some time to play around with ProjectionHub and run various scenarios to determine if and when your startup will run out of cash.