Cashflow in practice

Cashflow is the king is almost a guru mantra for start ups and bootstrappers. I wanted to explore this in a more practical fashion. Something like the corollary that renting is a better option than buying.

Lets again play with some simple numbers. Say you make 100 as your revenue in January and your profit is a nice 25% i.e your total expenses are 75. After paying your bills in first week of Febuary you are left with 25. Sounds simple and unfortunately is utterly false. This is what really happens

Revenue

Client A: 25, Client B: 20, Client C: 50, Client D: 5 = 100

Expenses

Salaries: 50, Rent: 15, Travel/Electricity/Phone: 10 = 75

Now as you know you have to pay all salaries by 1st of Feb, even rent and utilities will be paid by 20th of Feb. You will raise your invoices on 1st Of Feb. Let’s look at the possibilities

Date           Cash In         Cash Out        In Hand
Jan 1st           0                       0                        0
Jan 31st         0                       0                        0
Feb 1             0                       50                    -50
Feb 5th          20 (Client B)     15(Rent)            -45
Feb 15th        50 (Client C)     10 (utilities)      -5
Feb 25th        5 (Client D)       0                         0
Mar 1st          0                      -50                   -50

The above is probably an optimistic scenario. Usually it is an account like client C (the biggest) which pays the last. Here we have been benign and assumed only Client A’s payments spill into March. Obviously you might be earning revenues in Feb also but it won’t effect the cash flow on Mar 1st till which date we are tracking the above table. Also, some expenses would be incurred in Jan itself but this a contrived scenario mimicking reality only close enough to point a lesson.

Another very practical implication of this is the waste of time. You are probably already geared to be working overtime in January and got enough work to do that in Feb also. Now apart from doing the ‘actual’ work, you also need to be following up on payments with 4 clients. And if you don’t do that effectively, even the 3 payments in Feb won’t come on time. Anyways, you will slowly realize getting the money on time is ‘real’ work. All activities which lead to money coming in are the most important for a bootstrapped company.

Since life doesn’t follow simple arithmetic. How do you survive with a negative cash balance? The common way is that you would not start with a cash in hand on Jan 1st of zero. Given your projected expenses of 75, a seed capital of 150 is more likely. The other way to run a negative cash balance is to have an overdraft account with the bank. This is a facility no bank in India will offer to you in the first month and is only an option after 1 year of operation. If you have already completed 1 year and not asked your bank for an OD account – do it now!

Now that we understand how cash flow is working in practice, we will look at some implications on your business in a subsequent post.

update: Fixed the calculations (thanks Rohit!) and minor edits.