In the early days of a startup, projecting cash flow is relatively simple, because it’s a one-way street. Payroll, rent, R&D and maybe some legal costs equal the cash out the door, with no revenue yet to offset the cash burn. Modeling this out in a spreadsheet is easy for most entrepreneurs. 

Understanding cash flow gets a lot more complicated when an early-stage company starts servicing clients - and this is where we see super-basic, back of the envelope financial models start to breakdown. There are a few places where revenue-generating clients can “mess up” a nice cash flow model. This is where understanding and being able to model working capital comes into play.

Working Capital = the difference between current assets and current liabilities on a company’s balance sheet. What this really means for most startups is the difference between when a startup gets paid by clients vs. how long it has to pay your expenses. 

The timing of payments from clients usually starts pretty simple but can get complicated quickly. Super easy SaaS companies may collect a Stripe bill each month from their clients. Unfortunately, not all billing platforms wire revenue quickly. Some of the app store billing systems wait up to 60 days to share the cash with their app developers. It doesn’t take long before a simple SaaS business has a variety of receivables to wait on from a variety of billing platforms. Fast growth may mean that customer count is spiking (and costs along with it), but with lagging cash collection, even a gross margin positive customer can drain cash for a while.

Purchase orders make selling into the enterprise even harder. Just because a new Fortune 500 client signs a contract does not mean that payment is on the way. Many larger companies have a Purchase Order system that can add on months to the actual receipt of payment. And if different enterprise clients are requesting different invoices or purchase orders, payment can take a long time to show up.

On the positive side, companies that sell annual subscriptions can get large payments upfront. This can really boost cash flow but does create some modeling issues vis a vis deferred revenue and revenue recognition. (We’ve got a whole video on deferred revenue here).

Expenses that companies incurred as they grow sometimes are automatically paid every month (like your monthly bookkeeping cost)- but others may be paid “manually” - as in when the executive in charge of bill pay decides to pay them. Stretching bill payment does have a positive impact on cash flow, but may not be worth the manual effort. Plus, it may annoy your vendors to the point where they stop providing their service, so this is not a great game to play if you are a startup founder.

Thinking through your startup’s working capital will help you have better projections. Visit our startup financial modeling page to see more tips on how to manage your company’s budgets and growth projections!