FIDO's Law takes a bite out of small business cash flow problems. It's cash flow, not great products, that lead to startup success.
Even successful small businesses face cash flow problems, and the solutions are never easy.
Temporarily cutting back on staff or overhead may solve the cash flow crunch, but may create other problems.
FIDO’s Law (Firehose In, Drip Out) is a basic rule of thumb for keeping things in balance.
Simply put, it means getting money in as fast as possible, and paying it out on a timely basis but never sooner than you have to.
One of the biggest mistakes a young company can make is believing in the “Field of Dreams” school of entrepreneurship. If you build it, they will come, and everything else will follow.
In reality, many startups fail even when customers are knocking down the door. Getting too many orders sounds like a desirable problem, but in fact, it can be the source of a startup’s downfall if there is not enough cash on hand to fulfill those orders.
In fact, CB Insights ranks “running out of cash” as the second most common reasons start-ups fail. When a business runs out of cash, it isn’t always because there isn’t enough business. It could also be because there is too much business, and fulfillment costs money, and often must be done before customers pay.
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Managing cash flow means creating a hierarchy of five options.
When facing a cash flow crunch, the first course of action is to collect what is due as early as possible. The second course of action is traditional borrowing or opening lines of credit (often challenging for a small business or startup), and the third, to be used when those lines of credit are unavailable, is to explore alternative lending solutions such as factoring, crowdfunding, peer-to-peer lending options, or borrowing against assets.
Once those three options have been exhausted, the fourth is to adjust how much money is going out the door and how fast, and the fifth (last resort) is selling off inventory or assets.
Firehose Your Cash In
Getting paid faster is the most obvious strategy, and the one to tackle first. The U.S. Small Business Administration blog addresses this by recommending discounts for cash or “net 10 day” terms, and also reminds us that sometimes as an entrepreneur, you just have to be willing to nag people.
According to the SBA blog, “…the only way to get paid quicker is to call weekly and remind your customer that money is due and offer to take a charge card over the phone.”
This also leads to a second piece of advice, and that is simply to make it easy for people to pay, and to give them as many options as possible (credit card, PayPal, paper check, wire transfer, Bitcoin, cash, etc.). Bank of America also recommends electronic invoicing.
The latter is more than just a convenience, electronic invoices get to the customer faster, and are more likely to be paid sooner. Many electronic invoicing systems such as QuickBooks come with an option for single-click payment. Also, you can set up an “electronic nag” to send out automatic reminders and past-due notices.
Related Article:Small Business Cash Flow Woes? Know Your Options
Be Proactive, Until You Can’t
Armchair advisors, bankers, and small business counselors will tell you to plan ahead, and that’s always great advice, but it should never be the only rule to go by.
SCORE’s cash flow template is a good start. But as any startup entrepreneur will tell you, once your first year is done, you’re almost never where you thought you would be when you first launched, and Entrepreneur magazine ranks “overestimating future sales volumes” as one of the worst cash flow mistakes entrepreneurs make.
There are far too many variables in an early stage company, and exclusively relying on projections for cash flow management isn’t realistic. A more realistic approach combines that proactive stance with planning for reactive measures.
You may realistically estimate ten thousand dollars a month in sales and eight thousand dollars a month in expenses at the beginning of the year, and everything looks good on the spreadsheet until a competitor opens up shop next door and starts selling the same thing you have and for a nickel cheaper; your equipment goes on the fritz and you have to buy a new one and the bank won’t lend you money; and your biggest customer starts paying you late.
Suddenly, things aren’t lining up with that cash flow projection, and you need to have another few aces up your sleeve for when the unexpected happens.
Drip Your Cash Out
“Pay your bills on time” is obvious advice and generally wise, but a little too simplistic. Some of the largest and most respected companies set a pay cycle of 45 to 60 days or more, and it pays to negotiate longer payment terms with a vendor whenever possible.
In a cash flow crunch, you may even want to consider deferring payments to vendors. No financial manager will ever recommend this strategy, but for a company with a cash flow issue, nothing should be left off the table.
When a small business faces an imminent need to borrow, a quick analysis of the cost of cash versus the cost of paying late is in order. If the cost of borrowing is high with double-digit interest, but a late payment may impose just a small late fee, then it may be in the business’ best interest to consider the late fee option.
Having a good product and delivering great customer service are often cited as the keys to success, but even more important is maintaining enough cash flow to stay in business.
This is especially important in a competitive environment and an uncertain economy, and a company with a modestly acceptable product and good cash flow may stand a better chance of survival than a company with a great product and poor cash flow.
Paying attention to these issues, and planning for the unexpected from the very beginning, will help contribute to a small business’ long-term success.