Cash Flow Optimization Strategies for Venture-Backed Startups

Cash is king — and proper cash flow management is key to your startup’s survival as it navigates the various growth stages between fundraising rounds. Strategic cash flow management can help extend your runway and accelerate your startup’s growth, helping to sustain operational costs and gain an edge over the competition.

Cash flow issues are a leading cause of startup failure, with some studies estimating that more than 80 percent of startups eventually falter due to money issues. Furthermore, some data suggests that nearly 40 percent of startups prematurely close because they completely run out of cash, a statistic indicative of poor cash flow management.

Even profitable startups in high-growth modes may falter without positive cash flow. While profit is important for demonstrating your startup’s long-term potential, the consequences of insufficient cash reserves extend to an inability to cover operating expenses, missed growth opportunities, and increased vulnerability to unexpected market fluctuations.

In this post, we’ll explain the various cash flow dynamics that your startup may experience and share actionable insights and advanced strategies for optimizing healthier cash flow.

Understanding Cash Flow Dynamics in High-Growth Startups

Venture-backed startups rely on investor capital to grow, and this often leads to prioritizing growth over profitability, the latter of which often comes later. Startups that fail to monitor spending or plan appropriately may suffer from poor financial management practices, which can create a dangerous cash flow squeeze and jeopardize their runway. Venture-backed startups tend to operate with a high burn rate and negative cash flow for long periods of time as they aim to scale rapidly and aggressively, with the potential for significant returns coming as they mature.

However, startups still have to carefully navigate growth spending and cash preservation to maintain financial health and stability. Venture capitalists (VCs) invest with the expectation of significant growth and high returns, yet startups must still conserve the appropriate amount of cash reserves to maintain a cash runway to ensure viability.

Various dynamics can impact cash flow, one of which is customer acquisition cost (CAC). CAC can create timing mismatches when it’s paid upfront, while revenue earned from said customer is paid back over time. This is indicative of how startups often have to spend money to make money, yet balancing acquiring customers and covering expenses can be a challenge. Subscription models can help generate deferred revenue and create a more favorable cash position, but they can also create discrepancies between cash and earnings.

Accelerating Cash Inflows Through Revenue Operations

One way startups can strengthen their cash position is by transforming their billing and collections processes. Diversifying income sources through multiple revenue streams can also help reduce dependence on a single customer or product, creating a more resilient cash flow position. Some strategies for doing so include:

• Implementing automated billing systems. These systems can reduce days sales outstanding, accelerate payment cycles, streamline cash collection and minimize human error.
• Negotiate payments and contracts that front-load cash collection. This can improve cash flow, help your startup invest in growth and build up a financial buffer.
• Implement incentive programs that encourage prepayments and early payments. This is often done via discounted pricing, offering value-added features or services, or rebates. For example, offering a 15 percent discount on an annual prepayment versus what it would cost a consumer to pay monthly is one strategy.

Strategic Accounts Payable Management

How can you extend cash runway without damaging critical vendor relationships? Your startup can do several things to become more strategic with its accounts payable management. Here’s a look at how to work with vendors and other strategies for doing so:

• Negotiate extended payment terms with vendors: Extended payment terms with vendors can actually help strengthen partnerships, especially if you offer some sort of exchange to make any future agreement more mutually beneficial. Some ideas include committing to increased order volumes or offering referrals.
• Implement more robust approval workflows: More robust workflows can help optimize payment timing, automate invoice routing and matching, and integrate with other programs to streamline processes and prevent errors.
• Conduct a cash flow analysis to help properly balance early payment discounts against your cash flow needs. It’s important to make sure that discounts don’t trigger a cash shortage that would do more harm than good to your startup in the long term.

Working Capital Optimization Techniques

Optimizing capital is key to enhancing cash flow. Startups should strive to minimize any cash tied up in day-to-day operations without compromising growth. Identifying and addressing each cash flow pressure point, whether in inventory, accounts receivable, or subscription billing, can help prevent bottlenecks and ensure smoother operations. There are various ways startups can achieve this, from determining optimized cash conversion cycles to identifying capital inefficiencies to adjusting inventory management.

Inventory Management for eCommerce Startups

eComm startups are particularly challenged with inventory management, as a large portion of capital is tied up in inventory. It creates a balancing act between ensuring there’s enough stock to meet demand without over-investing in inventory to the extent that it saps cash flow.

Demand forecasting can be very difficult. It must be properly balanced so that items aren’t overstocked or understocked, and so that seasonal trends are accounted for. To forecast demand, rely on historical data, market trends and seasonal trends to make the most informed decisions on what to order. You can also set reorder points and work to determine proper levels of “safety stock” to protect against supply chain issues or fluctuations in demand.

Other inventory management strategies include:

• Exploring inventory financing or short-term loans to purchase inventory.
• Utilizing consignment options, which involve selling another company’s goods, with the seller only paying the owner after a sale.
• Implementing the right infrastructure for identifying and liquidating slow-moving inventory.

Subscription Billing Optimization

How can you maximize cash collection when using a recurring revenue model? There are various ways to optimize subscription billing if you’re running a SaaS startup. Some strategies include:

• Structure your pricing to encourage upfront cash flow via pre-payment discounts. Other strategies may involve offering simplified pricing tiers or utilizing a hybrid pricing model.
• Invest in the right billing platform to automate and streamline billing and collection. Specialized subscription management tools can help automate processes and avoid manual errors.
• Design upgrade paths when using your service that are able to encourage additional spending and generate immediate cash flow.

Cash Flow Forecasting and Scenario Planning

Cash flow forecasting can help manage risk and enable leadership to make more proactive decisions regarding cash management. Without accurate forecasting, poor revenue forecasting can create unexpected shortfalls, making it difficult to cover expenses or plan for growth. It’s best practice for startups to develop a 13-week cash flow forecast to provide crucial short-term visibility into their overall cash position.

To build an accurate 13-week forecast, gather historical and future cash data to help project weekly cash inflows and outflows as you create your model. Your cash flow forecast should be regularly assessed and refined to ensure accuracy. You can also create various trigger points that instigate cash preservation strategies.

Developing solid cash flow forecasts with multiple scenarios is also encouraged to assess for best-case, worst-case and the most likely situations.

Alternative Financing Solutions for Cash Flow Gaps

Looking to plug substantial cash flow gaps? Maintaining healthy cash reserves can provide a buffer, but when additional liquidity is needed, startups can explore alternative financing options that don’t sacrifice equity. Some options for bridging temporary gaps that don’t sacrifice equity include:

• Explore revenue-based financing: With RBF, you’ll receive an upfront lump sum of cash in exchange for an agreed-upon percentage of your future revenue.
• Explore a business line of credit, which can provide a flexible, revolving source of funds similar to a credit card. However, business lines of credit often offer lower interest rates.
• Another option is to explore trade credit and supply chain finance options. The former allows your startup to receive goods without paying up front, while the latter utilizes a third-party lender to pay suppliers early, thereby allowing for extended payment terms.

Technology Stack for Cash Flow Automation

Implementing modern financial tools can help provide real-time visibility into your cash flow and automate the process. The best platforms to select are those that integrate with other platforms and can streamline billing, collections and payment processing. Such solutions can often automate cash flow reporting and alerting systems to keep you on track. Many newer solutions also leverage AI tools for payment prediction and optimization.

Metrics and KPIs for Cash Flow Health

Several critical key performance indicators that your startup should track can indicate cash flow strength and identify optimization opportunities. Monitoring these metrics is essential for maintaining healthy cash flow, ensuring that the business can cover obligations, invest in growth, and navigate unexpected challenges. The leading metrics you should be tracking as they pertain to cash flow include burn rate, runway and efficiency ratios. Days sales outstanding and payable days are other key metrics to track. It’s best practice to create dashboards that provide real-time cash position visibility for startup leaders.

SaaS-Specific Cash Flow Metrics

If you’re running a SaaS startup, the metrics you want to know include:

• Cash collection rates
• Payment failure percentages
• Customer acquisition payback periods

There’s a unique relationship between SaaS bookings, billings and collections that startup founders should be aware of. Monitoring this relationship is key to tracking important metrics and gauging cash flow status.

eComm Cash Flow Indicators

Metrics that help drive cash flow optimization in eComm startups include:

• Inventory turnover
• Cash-to-cash cycle times
• Contribution margin after CAC
• The impact that returns and refunds have on your eComm startup’s cash position

Optimize Your Startup’s Cash Flow with Expert Guidance

For more information on the importance of cash flow and how to optimize it, contact Graphite Financial today. As a full-service financial services firm that specializes in working with startups, we know the critical cash flow challenges that early-stage startups face and have the knowledge and experience to meet them head-on. We’ll help you take a proactive approach to cash flow management and forecasting and set your startup up for success. Contact us today for more information and to schedule a consultation.

Frequently Asked Questions

How much cash runway should a startup maintain between funding rounds?

It’s best practice for startups to maintain a cash runway of anywhere from 18 to 36 months between fundraising rounds, though the ideal length largely varies by the state of your startup and current market conditions. It’s common for early-stage startups to aim for a 12 to 18-month runway, while more established startups often strive for a runway of anywhere from two to three years. A robust cash runway can help provide a buffer to help facilitate growth, navigate unexpected challenges and provide more control over the timing of fundraising activities. A robust runway can also help instill more investor confidence during fundraising rounds.

What’s the difference between cash flow and profit for growing startups?

Profit measures earnings by subtracting expenses from total revenue. Cash flow, conversely, tracks the money leaving and entering a startup’s bank account. Both are important for growing startups, albeit for different reasons. Cash flow is essential for day-to-day survival and can help ensure your startup’s ability to meet short-term obligations. Even a profitable startup can struggle if it doesn’t have enough cash flow to cover unexpected expenses. Profit, while also important, helps demonstrate long-term potential and effective cost management.

How can SaaS startups improve cash collection from annual contracts?

Several cash flow management strategies SaaS startups can implement to improve cash collection from annual contracts include automating invoicing and payment processes, incentivizing upfront payments to optimize cash flow, and taking measures to more strategically monitor and manage cash flow.

What are the best practices for managing vendor payment terms?

Proper management of vendor payment terms can help strengthen cash flow and vendor relationships, allowing your startup to better plan its finances while maintaining access to the critical goods and services necessary to operate. Some best practices for managing vendor payment terms include establishing clear policies, automating accounts payable processes and utilizing electronic payments. Your startup may also consider working with vendors to negotiate more favorable terms, utilize early payment discounts and commit to open lines of communication to facilitate good mutual working relationships.

When should startups consider revenue-based financing for cash flow?

Startups should consider revenue-based financing (RBF) for cash flow as soon as they have consistent, predictable revenue streams and a proven business model. RBF can also be utilized when startups are targeting specific growth, such as expanding sales, hiring, funding inventory or creating a bridge between fundraising rounds. RBF differs significantly from the other main method of raising capital (venture capital) and should also be considered based on your startup’s preference for ownership.

How do you build an accurate 13-week cash flow forecast?

A 13-week cash flow forecast helps provide crucial short-term visibility into your startup’s overall cash position, thereby allowing for better financial decision-making. To build an accurate 13-week forecast, gather historical and future cash data to help project weekly cash inflows and outflows as you create your model. Your cash flow forecast should also be regularly assessed and refined to ensure accuracy and to prevent any serious cash flow crises.

What cash flow metrics do investors focus on during due diligence?

During due diligence, investors focus on several cash flow metrics to help determine a startup’s long-term viability and potential to generate positive returns. Some of the key metrics investors can expect to assess include operating cash flow, free cash flow, net working capital, your cash flow statement and more.

How can eCommerce startups optimize inventory without tying up cash?

Optimizing inventory without severe cash flow challenges is best done by strategically blending forecasting and diversifying fulfillment methods to remain flexible. Some alternative inventory models compared to bulk purchasing include drop-shipping, consignment and just-in-time inventory. Implementing more data-driven inventory management with ABC analysis, demand forecasting and setting automated reorder points can also help your startup make smarter decisions. Finally, you might also look to optimize supplier relationships and seek more favorable payment terms.