‘Cash flow is king’: How startups can keep a positive cash flow

I was moderately surprised when professor Warren McFarlan said this at our first accounting class at Harvard Business School: “If there is one thing that I would like you to remember from my class, it’s that cash flow is king.” Then, he showed us a video clip of Cuba Gooding dancing and saying “show me the money” in the movie Jerry McGuire.

Photo credit: Niels Steeman / Unsplash

I remembered watching my dad struggle with his business’ cash flow when I was young. So, I was always mindful of this when running our first business.

But the modern-day startups don’t seem to care too much about it. When I ask how their accounts receivable (AR) are doing, some seem nonchalant about their more-than-a-year-old receivables.

Sometime back, I met up with a founder of an IoT startup who asked for feedback on his go-to market. After we covered that, I asked about his pricing thoughts and any payment policy he intended to have. The founder said something like these (numbers modified for privacy):

• “We need to make it easy for customers to commit, so the pricing can’t be too high. We will do a subscription model, then we will also be seen as a software-as-a-service model with ready recurring revenue and command a SaaS multiplier for our valuation.”
• “We will have tiered pricing to cater to different usage requirements. We will have a dashboard for users to monitor usage, so that will be the basis for the subscription pricing. Each system will cost us about US$150 to manufacture in bulk via OEM. We need to commit 1,000 for our first order.”
• “So, we will charge entry-tier customers a US$40 monthly subscription fee with a minimum commitment period of 12 months. We will make back our cost by month four per device with a bit of margin.”
• “We need to fundraise to get the US$80,000 up-front deposit to the OEM, as well as money for salary and overhead. So, we need to raise at least half a million for the next six months of operation.”
• “No, we can’t ask for an up-front deposit as it would make it hard for our customers to commit. They have to buy at least 20 to 30 units to start off. I firmly believe a monthly plan is a good way to bring customers on board fast.”

This is usually how conversations go. A pure SaaS play could do with a low subscription pricing model as the cost is spread out and the outlay is mostly for overhead and headcount. Not too crazy.

But, when you need to pay for deposits for molds and materials, it’s very silly to totally bank on venture capitalists to finance your cash needs. Even if you have to, try to shorten it to reduce your reliance.

You will be a lot less stressed and you’ll be a much happier founder when you rely on both customer funding and VC money for cash flow.

A few thoughts and observations

1. Subsidizing your customers’ cash flow with VC money (which directly translates into your equity and dilution eventually) – is it really the smartest option for you?
2. It’s perfectly common and understandable to ask for deposits or up-front (partial) payments, especially when you need to buy materials. The fact is, you have to pay your supplier up front to buy materials. Oh, but one may argue that this is because the manufacturer is a brick-and-mortar business, so they could get away with up-front deposits. The last time I checked, startups are also businesses!
3. Sometimes, when startup founders tell me that the customers refused to pay up front for hardware plays, I really wonder whether they got the right type of customers. Are the customers having a cash flow problem or plainly making use of them? Or maybe it just means that the startup’s overall value proposition is not strong enough yet.
4. Adopting a pricing model/strategy that’s not exactly ideal for your industry but doing so anyway for the sake of getting a higher valuation from VCs – is this really sound? Again, startup success does not come from getting a high valuation or getting funded. Success comes when you have customers buying your products/services over and over again and you make profits off them.
5. Be practical. For the first few deals, if customers find the product useful and want to “buy” instead of “subscribe,” for goodness’ sake, please say yes! I had met one startup that said no, as it violated his long-term business intention. Well, there is no long-term intention if you have no short-term survival. That company is gone now from what I know.
6. Quite a handful of founders I have met didn’t count overhead and manpower as costs, even for software companies. Investors will not be here to pay salaries and utilities forever.

Some cash flow-related lessons

1. Many startups do not watch their AR as they feel getting the sales done or the product deployed is more important. I would like to emphasize that managing AR/cash flow is just as important. Without the payment from your customers, you will be forever running your business on credit terms.
2. Do not overextend credit to customers. A customer who cannot pay is not really the type of customer that you want, no matter how big the brand.
3. Managing cash flow is not a job just for the finance team. It’s important to balance the sales team and finance team’s objectives.
4. If you can afford to pay your suppliers on time, please do so. It’s a cascading nightmare when one company doesn’t pay on time. Many companies go into receivership due to cash flow problems even when they have a positive margin.

This is an edited version of an article that was first published on the author’s blog and AngelCentral’s Resource Center.