The Startups Playbook for Cash Flow Sustainability

The success of a startup depends largely on its ability to secure funding, especially in the early stages. However, sometimes even well-funded startups can burn through their cash reserves quickly. 

For example, according to an article published in USA Today–consumer electronics brand Skullcandy, known for producing moderately-priced Bluetooth earbuds, burned through $26M in cash in just 12 months back in 2015. 

At the time, the company had just under $14M in cash and investments–or six months of runway left. When a cash-burning startup finds itself in a sticky situation with less than 12 months of runway left–what’s the next step?

It’s time to quickly pivot strategies to ensure survival. Here are six things we do for startups that need to quickly curtail cash burn and get back on track.

1. Build a Strategy for Cash Flow Sustainability
2. Review Your Product Roadmap 
3. Prepare a Restructuring Plan 
4. Evaluate Human Capital Needs 
5. Examine Gross Margin 
6. Control G&A Creep

Build a Strategy for Cash Flow Sustainability

Cash flow sustainability means that your business is bringing in enough revenue to cover expenses and pay your bills. It also means that you have enough cash to sustain growth and take advantage of strategic opportunities.

It’s more than being cash flow positive–it’s about being financially healthy.

For many startups, the reality is a high burn rate and an ever-looming end of their runway that threatens to close the doors. But often, businesses with a high burn rate can turn things around with the right strategy. Here are a few steps to get started on the right path.

Step One: Clarify Goals

The first conversation on the table should be about what big-picture goal the business is trying to accomplish. For example, it may be to become cash flow sustainable. Or it may be to prepare the business for a sale. Many private equity firms are open to acquiring money-losing tech companies, but there needs to be a clear path to cash flow breakeven.

Even when a startup is looking to expand market share, growth is only good if it’s sustainable. 

For example, a fast-growing nutritional supplement company started out with a direct-to-consumer (DTC) business model. A few rounds of successful Facebook advertising campaigns skyrocketed business and caught the attention of a few national retailers.

As the company negotiated contracts with major retailers like CVS and Publix that brought exposure and mass distribution, the supplement company experienced unprecedented growth. Initially, management and the investors were ecstatic.

Pretty soon, inventory shortages started threatening fulfillment contracts, and the company found itself in a tight spot–short on cash and unable to scale production or bulk up inventory. That’s when they enlisted the help of an advisory firm to get a handle on their finances.

Without intervention, this growth wasn’t proving to be sustainable. 

Name whatever goal is driving your desire to become cash flow sustainable so that you can align key decisions with the right priorities.

Step Two: Create a Plan

Next, map out the tactical steps that your business needs to take in order to achieve this goal. Start by analyzing your current cash flow. Comb through your income and expenses with a fine-toothed comb to get a realistic idea of what’s coming in and what’s going out.

Make sure that you have a good understanding of your cash conversion cycle and that you have identified areas where there might be a cash flow issue.

This might include:

• Late Payments from Customers
• Seasonal Changes in Revenue
• Excess Inventory Bulk
• Rapid Growth

Once you have a good idea of what is currently happening, the next step is to do some brainstorming. You want to create two lists: the cut list and the add list. On the cut list, you want to think about things that you can reduce–like inventory on hand or dollars spent on inventory by changing suppliers. And on the add list, you want to think about things that you can do to increase revenue, like improving payment collection times.

Now that you know what you need to do, start assessing the items from your wishlists and fitting them into a plan that you can implement.

Step Three: Understand Funding Landscape

Context is really important, especially when the funding landscape is very fluid. There have been years–even entire decades–when funding was seemingly always available. But that hasn’t been the case through the first quarter of 2023.

Even before the Silicon Valley Bank failure, funding was already tough. One reason that prospects might be in short supply is that all trends point to more trouble brewing for startups. Carta’s State of Startup Compensation Report highlights mass layoffs–especially in big, public tech companies and stagnant salary growth as indicators that the startup world is in conservation mode.

This means that cash-burning businesses are taking more steps to hold onto the cash they have. Given the current market–now is the time that you want to be nimble and adjust quickly because conditions can shift at any moment.

????Here’s What to Do: Set a Goal, Make a Plan, Track Your Cash & Optimize

Budget cash flow on a weekly basis, if possible, and monthly at a minimum. You have a plan, so if you see the business veering off course, it’s better to continuously monitor and make micro-adjustments now rather than course-correct later.

In May 2022, Sequoia Capital shared a presentation to its founders on “Adapting to Endure.” In this presentation, they outlined the “Survival of the Quickest,” which illustrates how the speed to adapt can impact the trajectory of a company. Those who are prepared to take action within the next 30 days are the most likely to avoid the ‘death spiral’ while everyone else will still be sinking funds into research and development or marketing while their runway evaporates.

Put your plan into action with tactical steps toward cash flow sustainability Planning is only part of the process. To make a change, you also need to take action. From taking another look at your product roadmap to rethinking how you use space–here are the tactical steps that will help you reach cash flow sustainability.

Review the Product Roadmap

Start by looking at your products. Review your product roadmap with an eye toward return on investment (ROI). The thing that really burns cash is the novelty of big trends that don’t pay off. If you have six projects that you can bring to market in the next 18 months–sit down and do an analysis to see which ones have the best commercial viability.

Ask questions like:

• Does this product have a well-defined market that’s ready NOW?
• Is the product easy enough to understand? Will your sales team be able to quickly learn about it and sell it?
• What does your product sales cycle look like? Is it long or short?
• Do you have products in the same family? Can you combine resources?

Do not let perfect be the enemy of good–push your R&D teams to release viable products when they work and address a need. You can continue to improve the product after it starts producing revenue, as long as it is producing revenue.

Your product roadmap will help you narrow your focus. From here, you can realign resources. Costs that do not directly match your goals should be eliminated.

Prepare a Restructuring Plan

A restructuring plan involves a significant change to staff, operations, or finances to improve efficiency. It might involve:

• Reducing Staff
• Consolidating Operations/Closing Facilities
• Redefining Job Roles & Creating or Eliminating Positions
• Selling Non-Core Assets
• Aggressive Cost Cutting

Reducing staff is hard on morale. It’s a major distraction that will affect sales and productivity as everyone worries about their jobs.  It requires meticulous change management. Every round of layoffs creates more job insecurity among the remaining staff.

What and how you communicate change can make a big difference in how your team responds. If you leave them guessing, there’s a good chance that your best talent will find new jobs–leaving you with a lot of inexperienced or low-performing staff, compounding the disruption to your service and productivity levels.

As you prepare your restructuring plan, focus on extending your runway so that you can maintain confidence among the remaining staff that they are part of your go-forward plan. You want your sales staff to be focused on selling your products–not finding new jobs.

Even if layoffs are not part of your restructuring plan, your team might become concerned when they see other big changes occurring around the company.

A restructuring plan should include the following:

• Clearly Defined Reason 
• A SWOT Analysis
• Objectives & Goals
• Strategies
• Resource Requirements
• A Tactical Timeline
• Identification of Stakeholders
• A Communication Plan
• An Implementation Plan & Follow Up

Evaluate Human Capital Resources & Investments

Layoffs aren’t the only way to trim labor costs. Some organizations look for bloat in the human resource department–and that can be a risky move. Sure, some of your employee perks might be delivering poor ROI, but stripping benefits tends to raise a red flag for the workforce. 

The way that you position cost-savings or cost containment can have a huge impact on the team you have tapped to move the company forward. A tactical adjustment by eliminating a department or a few team members is an easier message to deliver than reducing everybody’s benefits.

Why? Layoffs are, unfortunately, routine in business, but scaling back on benefits–that’s a sign that the company is having deeper problems. And if the employee base begins to lose confidence in the company, everything is at stake. These disruptions can quickly threaten sales, production, or development, and the effects can be so detrimental to cash flow that the company cannot recover. 

Remember the death spiral? The point of certain doom and inevitable destruction of a business comes long before the doors are closed. It starts here–with human capital–sales, development, and operations. 

While you’re cutting costs, resist the temptation to save money by effectively lowering an employee’s total compensation package. Employee perks, traditional benefits, and 401(k) matches should effectively be considered off-limits. 

Find these savings some other way. Instead of trimming benefits across the board, consider eliminating two additional positions. The impact will be localized–and with unemployment under 4%, you’ll keep your top performers engaged and focused on your future success.

Examine your Gross Margin

Gross margin is a measure of profitability from sales after deducting the cost of goods sold (COGS). Essentially, it tells a company how much money they are making from its products or services.

It’s an essential metric for:

• Determining Profitability,
• Pricing Strategy,
• Measuring Operational Efficiency,
• Competitive Analysis

When working towards cash flow sustainability, your gross margin can help you understand labor utilization, manage vendor relationships, and gain control over your inventory–all common causes of uncontrolled spending in cash-burning businesses. It’s important to keep in mind that gross margin has to be evaluated by product/service type or by channel etc. as each may have different opportunities to optimize and improve cash flow.

1. Labor Utilization & Cash Flow Sustainability

Let’s look at labor utilization as a cost driver. Depending on the industry, labor can cost anywhere between 20% and 50% of your total revenue. Of course, for service-based businesses with highly skilled labor, the number is always going to be higher than retail or foodservice sector labor.

But if you’re comparing apples to apples with the same skill levels in the same industries, there shouldn’t be a wide swing of variation in labor utilization from one company to another. Big discrepancies might indicate that the company isn’t using its workforce efficiently to produce revenue–thus, spawning layoffs and restructuring to correct the course of the organization.

???? What You Can Do: Compare your labor utilization rates to competitors in your industry. Set a goal that is in line with your current utilization and with traditional benchmarks in your industry. Then, identify 3-5 action steps to improve labor utilization.

2. Managing Vendor Relationships 

Another key area where you can make a big difference in the financial health of your company is vendor relationships. Work with your vendors to help reduce costs, improve durability, and reduce overhead.

It’s basic fundamentals–you won’t get a price concession unless you ask for one.

For example, a company that had built a diagnostic tools instrument was flooded with great consumer reviews for a terrific product. However, their COGS was unusually high. Why? Probably because parts of the design were over-engineered.

For instance, it had a plastic box that used a dozen different-sized screws. A little simplification in that design could reduce the hardware components to at least half of the current number. With fewer different components, the procurement team could have negotiated more substantial volume savings. 

Or, in an even more proactive approach, they could have worked with the vendor to find the best value by adapting the design to utilize a screw size that they were already making for other clients. A little more collaboration between R&D, procurement, and finance could have led to further price savings, shorter lead times, and a smoother vendor relationship that wasn’t eating up cash.

And that begs the question…how much more cash is sitting in inventory?

???? What You Can Do: Create a process for continually evaluating vendor relationships alongside vendor costs to flag and review opportunities. A simple checklist for evaluating vendor relationships can be a useful tool to start a comparison.

3. Revisit Your Inventory Plan

The supply chain issues of the past few years led to many companies increasing their inventory levels beyond what would have been unheard of before the COVID-19 pandemic. According to S&P Global Market Intelligence, inventories today are 53% higher than the 10-year-average pre-pandemic. 

As the supply chain pressures have eased, now is the perfect time to take a look at inventory-on-hand and look for opportunities to reduce volume because–really, all of that product is cash sitting on shelves.

If your pre-pandemic inventory levels were at a 30-day capacity and now you are sitting at 150 days, you can feasibly reduce your inventory to 60 days. This adjustment can save a lot of cash and extend your runway, getting you closer to cash flow sustainability.

???? What You Can Do: Monitor inventor level by SKU, channel, etc.,  alongside customer demand. Proactively manage your inventory levels to optimize for cash.

Control G&A Creep

General and administrative costs are another area that adds up to significant costs–and provides ample opportunity to make some healthy adjustments. A realignment of expenses in R&D and sales might mean less required support staff, less space, fewer software licenses, or fewer professional services to support day-to-day operations.

1. Understand Your Space Requirements

Do you own your building, or are you under a lease? If you signed a 4-5 year lease before the COVID-19 pandemic–has your operational or work structure changed? Are you–or could you–utilize a hybrid working scheduling to reduce office space needs? 

Evolving to a workstation model with a handful of meeting rooms instead of dozens of individual offices can eliminate 30-50% of the office space you pay for. And if location or commuting isn’t a major concern–consider shopping rents in a lower cost-per-square-foot market.

“At the Gazette, we had a 100,000 square foot building which included 40,000 square feet for manufacturing and storage and 60,000 square feet of office space. With minimal investment, we provided tenants with a “white box” that allowed them to build out their space to their liking. We brought in 4 tenants–renting over 35,000 square feet of space–generating enough revenue to pay the property taxes and hire a facilities manager to maintain the property and finally tackle a long list of to-do’s. This was a huge cost savings–leading to Gazette Companies effectively paying ZERO rent.”

—Lance Geda, Embarc Advisors (FMR Gazette Companies)

???? What You Can Do: Create a plan that reduces your facilities-related expenses by renting out extra space or relocating to a lower-cost facility.

2. Review Support Staff

How much staff do you really need? If you’re not actively recruiting, you probably don’t need internal recruiters. If you’ve made significant changes to your operations, maybe your finance or legal needs have also changed.

Do you need full-time support? There is a growing number of professional services available as fractional services–which means that you only pay for the hours that you use. For example, many small and medium-sized businesses need a Chief Financial Officer, but they don’t need (or can’t afford) to keep a full-time CFO on staff. 

Instead of relying on their bookkeepers alone or spending large sums on more support than they really need, these companies can benefit from Fractional CFO services.

???? What You Can Do:  Look for opportunities to reduce reliance on professional services or at least pause hiring for these positions. Evaluate opportunities where outsourcing for fractional services might make more sense.

3. Review Technology Assets & Infrastructure

Take a close look at your software licensing and other technology-related costs. Sit down with your IT director and have a real conversation about current and projected needs and look for opportunities both immediately and in the near future.

Look for opportunities to cut back on:

• Software Subscriptions
• Cloud Storage Services
• Printing Costs 
• Telecommunications Services
• IT Operations (Outsourcing vs. In-House)
• Hardware (e.g. physical workstations, data center model)

???? What You Can Do: Make a map of technology needs, contract renewals, and required notice dates and prioritize contract negotiations based on what you can cut–and when.

Communicate

If your current cash runway is not where you need it to be, make changes, then communicate the effects of those changes and when your investors will see those changes reflected in your results.    

Before you go to your investors, outline your complete strategy for cash flow sustainability. Identify the primary goal in the context of current market conditions in your industry and craft a compelling, solutions-oriented purpose and objectives for the change.

Your stakeholders will need to know that you have thought every facet of this major change through because as much as it promises to cut costs and bring you to cash flow positive–there are still many moving parts, and a lot can go wrong.

Then, identify all of your stakeholders. Your investors are top of the list, but they’re not the only ones who need to know. Take time to diligently consider how you will frame conversations with employees and customers regarding any changes that might be visible at different levels.

Develop key messages for each audience, identify appropriate channels, and create a timeline of exactly what to communicate and when so that you’re never leaving a gap between what they see and what they know.

All of the diligent FP&A that you’ve put in up until now could all be wasted if investors and employees start to panic.

Bottom Line–The Longer Your Runway, The Stronger Your Position is for Whatever Comes Next

Whether you are contemplating a future sale or looking to add a little more ‘bounce’ for economic resilience–cash flow sustainability is the goal. Think of it this way, if you are looking to raise capital and an influx of cash will buy your company another 18 months of runway–that sounds a lot better to potential investors than saying a new raise might buy you 1-2 quarters. 

How Embarc Advisors Can Help

At Embarc, we bring deep expertise in financial management, planning, and analysis to support startup sustainability. Our approach is different. We have found that no single person can effectively undertake the complexities of FP&A–and do it well. 

That’s why we provide a team-based approach to ensure our clients receive dedicated attention and knowledgeable expertise from every angle. We provide extensive experience ranging from startups to public companies with experience in growth, turnaround, restructuring, and M&A.

Reach out to Embarc Advisors to discuss your financial management strategy today!