Why Successful Startups Fail

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Josh is considered a successful entrepreneur. His new business is the talk of the town. There are new customers every day, and everyone loves his shop. The growth is remarkable. Even Facebook hadn’t expanded this fast. But, there is something wrong. The growing number of customers, the ballooning market, and the sheer volume of transactions should have made Josh a rich man by now. Instead, he is having difficulties paying interest. This month, he had to sell his car to avoid foreclosure of his premises.

But, how can that be? Is he being robbed? Did he miscalculate his profits? No, Josh wasn’t robbed, and he didn’t miscalculate his earnings either. Josh’s business is suffering from what is known as a cash-flow crisis. A cash-flow problem happens when your business, no matter how profitable and valuable, does not have CASH to pay its short term debts. This can happen for many reasons. Rapid expansion, inadequate credit control, and high debts are some.

Imagine you take a loan of $10000 and start a furniture company. You buy a used van for $4000 and purchase furniture with the rest. Starting next month, you’ll also have to pay rent. To attract customers, you provide an attractive buy now, pay later scheme: customers can take home their furniture today and pay instalments starting next month. Customers love this offer and buy a lot from you. However, they do not give you any cash today; they’ll start paying next month. In your books, your business is a success; you have hundreds of customers. At the end of the month, your landlord comes up to you and asks you for rent. You look at your bank balance, only to find that, lo and behold, it’s almost nil! Now, you could beg your landlord for mercy, and you could explain your predicament. But why should he believe your word? You have had new customers every day for the past month! How are you to clarify that the sales did not generate immediate cash?

The furniture company example is a classic cash-flow crisis. Many businesses solve such troubles through new loans. You could ask your bank for additional loans to pay your landlord. Banks are keen to lend to expanding businesses, and if you are careful, this is a valid technique for tackling your problems. But, if startups frequently incur cash flow problems, the frequency of bank loans increases. Eventually, the business ends up unable to pay the ever-rising interest. This situation is the same as that of Josh.

Chronic cash-flow crises are a common issue. But there are ways to overcome this financial illness.

1. You need to learn cash flow forecasting. This is a must. If you are not familiar with the term, Google it. Cash flow forecasting is similar to budgeting — you are allocating cash for your future. There are hundreds of Youtube videos that explain this idea in detail.
2. Before you agree to provide credit to new customers or plan to implement a new credit scheme, analyse how this affects your future cash flow. You should explore how the new credit scheme will reduce your cash-flow, and draw up a new cash flow forecast based on that. If you end up with a negative projection, avoid extending credit.
3. Always try and extend credit terms with your suppliers. The longer you can avoid paying your suppliers, the better your cash position will be. So, never deny an opportunity to pay later.
4. Practice proper inventory management. Imagine you purchased more inventory than you sell. This practice will tie up cash that you could otherwise use to clear debts. There are plenty of videos on the internet that help you learn about inventory management. Watch them.

Startups do not fail because they are not valuable; they fail because the managers fail to manage. Remember, a profitable business with a cash-flow crisis rarely survives, but a mediocre company with a well-managed cash flow always pulls through.