Everyone talks about the importance of cashflow. Every start up book says, cash is lifeblood and without it you die. Cash is king – no dispute. If you are wondering why it is such an issue, so was I.
The Cash Trap:
Definition – The gap in ‘time’ and resulting cash flow impact between paying suppliers and receiving actual payments from sales to customers.
When starting a business you have to pay for everything up front. Everything from stationary, to product inputs to manufacturing runs. All these will need to be paid for prior to receiving services as you do not have a payment record. Put simply, suppliers are not sure you’re good for it.
On the flip side, when trying to get new customers, it is very hard to demand money up front. Most re-sellers have terms of trade. For example, payment net in 30 days. This creates the cash trap. In my blog entry 4, I wrote about the customer being the consumer as a must have. The ‘cash trap’ is the reason why. It reduces the impact of the cash trap. It improves cash flows by reducing the gap in time between inputs paid to revenue received. A business with very short business cycles and consumer direct interaction may even eliminate the cash trap.
Huge margins are irrelevant, until you have received the cash from the sale. In fact in a start up with a lengthy cash trap, growing too quick can be you’re worst enemy. Strong sales early, can send you broke.
Profit and solvency are not inextricably linked.