For many early-stage startups, cash flow projections at first seem simple – just track payroll, rent, R&D expenses, and a few legal costs, tally the outflows, and you’ve got your burn rate. But as soon as your company starts generating revenue, the picture becomes more complicated. This is where understanding working capital becomes crucial for accurate cash flow management.
What Is Working Capital?
Working capital is defined as the difference between your current assets and current liabilities. In practical terms for most startups, it’s the gap between when you collect payments from clients and when you have to pay your own bills.
Why Working Capital Matters for Startups
As your company grows and begins servicing clients, the timing of cash flows becomes a major concern:
- Customer payments. In simple SaaS models, clients may be billed monthly through platforms like Stripe, which can result in predictable and relatively quick payments. However, not all billing systems pay out immediately – some, like certain app stores, may take up to 60 days to deliver funds. Fast-growing startups may be waiting on a growing pool of receivables, meaning even profitable customers can temporarily drain cash.
- Enterprise contracts and purchase orders. Selling to large companies often introduces lengthy purchase order (PO) processes. A signed contract doesn’t guarantee quick payment; PO systems can delay cash receipts for months, particularly if clients require unique invoices or have slow internal processes.
- Annual subscriptions. On the positive side, selling annual subscriptions can provide a significant up-front cash boost. However, this also introduces complexities with deferred revenue and how it’s recognized on your financial statements.
- Paying expenses. Some expenses, like software subscriptions, are paid automatically each month, but others are handled manually. Delaying payments on certain bills can help your company conserve cash, but stretching payments too far can irritate vendors or jeopardize key relationships.
How Startups Can Manage Working Capital for Better Cash Flow
- Track receivables closely. Regularly review your accounts receivable to spot late payments or trends that could signal future cash crunches.
- Monitor payment terms. Negotiate favorable payment terms with both customers and vendors to improve your cash position.
- Model working capital in forecasts. As your startup grows, include working capital assumptions in your cash flow projections to get an accurate sense of runway and avoid unpleasant surprises.
Thinking carefully about working capital will lead to better financial forecasts and greater confidence in your startup’s ability to scale. For more expert tips on managing startup finances and building robust growth projections, connect with the team at Kruze Consulting.
