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3 essential steps for startups to keep enough money in the bank

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Until your startup is profitable and generating positive cash flow, there is one fundamental question you should be able to answer at any time: How much runway do you have left? Many founders think this question pertains to when their cash balance reaches zero. Unfortunately, you will be in trouble well before then.

As your cash balance approaches the danger zone, your auditors may issue a “going concern” memo. Your bank may become nervous and limit access to critical debt facilities. Major suppliers will worry when you start stretching payments, tighten credit terms, or even need cash upfront before shipping that next order.

You need to know the point where your cash balance gets so low that you risk losing control of your business. Here are three essential steps to ensure you always have enough cash in the bank:

Related: 10 Expert Tips for Managing Cash Flow as a New Business

1. Calculate how many months of cash you have

From the early days of Microsoft, Bill Gates insisted on at least… enough cash in the bank to keep the company alive for 12 months if sales fell to zero. Gates understood that cash equals control, and he never wanted to be in a position where he NEEDED money from someone else to ensure the company’s survival.

When considering how much of a cash balance to hold, use your forward-looking monthly forecast for operating expenses, inventory purchases, and capital expenditures. Don’t rely on historical spending patterns. Most startups are in a growth trajectory that regularly drives up costs and investments, meaning your forward-looking goals will be higher.

2. Check Out These Two Simple Proportions Every Month

If you’re just looking at your cash balance as an indication of financial health, you’re ignoring the condition of the rest of your balance sheet. Most importantly, how do your current assets compare to your current liabilities, defined as liabilities due to be settled in the next 12 months? Two simple ratios should be a consistent part of your monthly reporting: the quick and up-to-date ratios.

The fast ratio measures your company’s ability to cover current liabilities with your most liquid assets, such as cash, marketable securities, and net receivables (“quick assets”). The formula for the quick ratio is: Quick Assets / Current Liabilities.

The current ratio, a less conservative measure, compares all of your current assets, including inventory and prepaid expenses, to your current liabilities. The formula for the current ratio is: Current Assets / Current Liabilities.

These ratios help uncover hidden problems that could be masking an apparently healthy cash balance. For example, when your business begins to miss sales targets, you will likely stretch payments to suppliers to maintain your target cash balance. Current and fast ratios can let you know when those deferred payments create a level of risk in current liabilities that can quickly spiral out of control.

The target for these ratios will vary from company to company. Large red warning lights should flash if you have a ratio less than 1.0. Your Board of Directors may want you to maintain a certain ratio to avoid starting a fundraising or sales process. There may be industry averages that you can use to compare your company to peers.

Assuming you have debt facilities, your bank may also have a position, leading us to the third step.

Related: Long-Term Success Starts With Managing Your Startup Runway

3. Keep an eye on your bank covenants and “Events of Default”

Another reason why simply relying on your monthly cash balance is a mistake is that you probably have debt facilities that you have used to bolster your cash position. Triggering a default with your lenders can put your business in a precarious position.

First, be aware of your financial bank covenants. Often, these covenants contain a quick or current ratio target that you must maintain over the life of the loan. This is the bank’s way of making sure you have enough liquidity to keep up with payments and ultimately pay off your debt.

Also, keep in mind that insolvency can trigger a default condition, allowing your bank to pay off your debt and demand full repayment. This provision is usually tucked deep into your loan agreement, under the “Default Events” section. Insolvency is a technical term that means that your total liabilities exceed your total assets. You can have cash in the bank, pay your debts on time and still be technically insolvent.

Maintaining adequate cash and liquidity levels is the key to always being in control of your company’s prospects. With so much to think about as a founder, it’s easy to get lost in the weeds of weekly reporting and performance stats. When all is said and done, spend a little extra time each month taking these steps to reassess the financial health of your business, and you’ll avoid nasty surprises that suddenly narrow your future options.

Related: 5 Ways to Keep Your Business Finances Healthy


Shreya has been with australiabusinessblog.com for 3 years, writing copy for client websites, blog posts, EDMs and other mediums to engage readers and encourage action. By collaborating with clients, our SEO manager and the wider australiabusinessblog.com, Shreya seeks to understand an audience before creating memorable, persuasive copy.

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