Business schools teach all kinds of cash flow principles. Find the optimal mix of debt vs equity financing. Minimize the operating cycle, or the time between purchasing inventory and collecting cash. Take early payment discounts. Use credit lines. And so on. These principles are all important, but I didn’t learn in business school what to do when a startup doesn’t have enough cash to pay all of its bills. The reality is that many businesses wouldn’t even be started if they had to fit nicely into the theoretical box of optimal cash flow practices.
It always takes much longer and much more money than expected for a startup to become profitable, if it gets there at all. Even profitability may not be enough to cash flow the business when working capital and capital expenditures grow with sales.
Most startups struggle to pay all the bills before the business cash flows itself. It’s important to have a plan for getting through these tough times. Cash flow struggles do not need to equal failure (even though it may feel that way when you’re in the middle of it).
Here are some things to do when you can’t pay all the bills:
1. Communicate
It’s hard to communicate with those we owe money to when we don’t have good news. We may hope they don’t notice we’re behind. If they start reaching out to us, it’s tempting to avoid them until we’re able to pay.
We tend to fear the worst reactions, but it's surprising how patient most vendors will be if you communicate well. Most won’t yell at you or insult your mother. Most will be willing to give you extra time or put you on a payment plan without too much fuss.
2. Prioritize
Not being able to pay all the bills is tough for honest people. We want to pay everyone in full and on time, if not early.
However, sometimes this is simply not possible. We have to prioritize carefully, or we’ll end up killing our business by giving our precious cash to those who can wait (i.e. vendors with mean collections people) and not having any left for those who can’t (i.e. employees).
Payroll can’t wait. People are everything, and if you can’t pay the people critical to running your business, they will leave. When times get better, your reputation will prevent you from hiring good people.
Notice I said “critical” people. You need to pay everyone on payroll, but you don’t need to keep everyone on payroll. Tight times give you a good reason to identify team members who are coasting or holding the team back. Cutting back your payroll not only frees up cash for other bills but also refines your team.
Payments with severely punitive default terms can’t wait. For example, some bank or hard money loans may require late fees and a drastically increased interest rate if payments are late.
Most other bills can wait. Every business is different, but think carefully about priorities.
3. Be creative
There many options for raising money when you are struggling with cash flow. Don’t be afraid to look beyond the traditional friends and family, bank loans, credit cards, etc.
Loyal customers can be a source of financing. If you're running a great business, you should be important to your customers’ success. They don’t want to see you fail.
I know someone who sourced the product he sells from several different manufacturers. He provided great service to his customers, and they loved him. However, in some cases the manufacturers wouldn’t deliver on their promises, which made it difficult to meet his customers’ needs.
He had the opportunity to set up his own manufacturing facility but needed funding for the equipment. His loyal customers knew this would provide them with much better service. Several of them prepaid for large orders at a discount, giving him the time and capital to set up the plant.
Conclusion
It goes without saying that we should do our best to pay all of our bills, on time. However, when building a business sometimes it simply isn’t possible, at least in the short term. When this happens, it’s important to have a plan for getting through the tough times with the least damage possible.
Question: What tips do you have for startups struggling with cash flow?