5 strategies for startups to avoid financial ruin

In India, startups have become the new trend, the dream of most engineering and business management graduates and even of many dropouts. The year 2015 saw several being set up every day in every conceivable field. 2016, however, has witnessed a reverse trend. Not only has there been a fall in the number of new startups springing up but, also, many are shutting shop. Moreover, the decrease in the inflow of funds this year has resulted in some minnows merging with older and larger ventures.

For every startup that succeeds, there are many hundreds and thousands that fail despite being highly innovative and wellfunded. The reasons are many, but most are related to financial mismanagement. If budding entrepreneurs paid half as much attention to the financial aspects of their startup as they do to the technological, marketing, valuation and fundraising aspects, their chances of survival and success would be far greater.

Here is a shortlist of things an entrepreneur should do to run a sustainable business. 

Be clear about the revenue model

While much thought goes into the ‘idea’ that has captured the entrepreneur’s imagination, not enough attention is paid to the financials and the revenue model. Without a clear idea of how and from where the revenues are going to be generated, the venture would be a non-starter. Businesses cannot be run for long on investors’ money alone. It is okay during the gestation period but, soon, the business must generate enough revenues to at least meet the operational costs.

Generate profits and not sales

In those cases where there is an understanding of the revenues, the entire focus is usually on increasing the top line. Entrepreneurs must never forget, however, that the business of running a business is not to generate sales but to make profit. Selling is a means towards an end, and the end is to make a decent, healthy profit.

If your role models are the Flipkarts and Ubers of the world, with all energies concentrated on generating volumes while making cash losses per order / ride, you must also understand that you need to have very, very deep pockets to continue doing that for any length of time. Chances are pretty strong that the business will go belly-up well before a white knight investor comes along to invest his millions impressed by the sales volume.

While drawing up the business plan, there should be complete clarity on how the business is going to make profits.

Pay attention to the cash flows

One of the first lessons that an entrepreneur learns is that there is no connection between the profit that a business earns and the bank balance it has. In fact, if there is a connection, it is inverse – i.e. the higher the profit, the lower the bank balance. This article is too short for me to elaborate further, but take my word for it right now!

A question that perpetually haunts an entrepreneur is: “Where is the money?” Accountants tell you that the business is making impressive sales and profits, but where is the money! Why can’t you see it in the bank?

Well, you are making profit precisely because your money has been deployed. If you started hoarding it in the bank, it would be a matter of time before you too stop making a profit. There is no pleasure in making profits if, at the end of the month, you don’t have the money to pay salaries.

Always remember that successful businesses stand on two pillars: (1) the ability to generate profit, and (2) the ability to manage cash flow, effectively.

Working capital is very essential 

While evaluating the funds that a startup needs, it is relatively easy to understand the amount of fixed capital required. But often the working capital requirement is not clearly understood. Consequently, many such ventures are starved of the working capital for sustaining the operations on a day-to-day basis. Among those businesses that close down due to a shortage of funds, a large percentage of them do so due to a shortage of working capital.

Working capital is required primarily for three things:

1. Purchasing materials and maintaining inventories (in case of organisations engaged in manufacturing / trading);
2. Meeting day-to-day operational expenses; and
3. Investing in your customers, where goods and services are sold on credit.

It is suicidal to use short-term funds for long-term purposes

Startups must take great pains to ensure that only long-term funds are used for long-term purposes and short-term funds are used for short-term purposes. Never ever use short-term funds for long-term purposes. It would be suicidal to do so.

If start-ups pay heed to the finance management aspect of their business it will go a long way towards sustaining their venture and making it a success.

(Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the views of YourStory.)