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Cash Flow Trough

Whether you’re a young SaaS startup flexing your subscriber wings or a long-standing operation with experience to spare, cash is often the lifeblood of your business. Where would we be without it, and how does cash flow really affect a SaaS business?

What is cash flow?

Cash flow determines the movement of both physical and virtual money in a business — essentially named as such because the cash “flows” both in and out of a company. Cash comes in via payments from customers, who can be subscribers to your SaaS business, and cash goes out in the form of payments, expenses, and other operation costs. The difference between these two figures is known as net or cumulative cash flow.

If you have more money coming in than going out, your business is going to experience positive cumulative cash flow. If you have more money going out than coming in, you’re going to experience negative cumulative cash flow.

Information about your business’s cash flow should be located on your cash-flow forecast sheet. This can be a basic spreadsheet or integrated with your accounting software.

What is a cash flow trough?

SaaS business owners often bear the brunt of experiencing negative cash flow — often referred to as the “cash flow trough” — in their first year trading.

Cash flow trough occurs because business owners have to initially invest on marketing to acquire customers and subsequently only recoup this expenditure over a certain (and often prolonged) period of time. This results in negative cash flow because the outgoing costs are higher than the amount of incoming cash.

For example: you’re a new IT startup who sells cloud-based storage via a monthly subscription. In your first month, you spend $300 on customer acquisition costs (CAC) and this brings in one customer who pays $30 per month over a 12-month subscription.

Control - Cash flow trough graph

The above graph shows us that our online storage SaaS business experiences negative cash flow for the first 11 months of its lifecycle before digging itself out of the trough. This is because the initial CAC is higher than the amount of money coming into the business due to the subscription-based business model. This example uses a single customer cumulative cash flow only, so what happens when a SaaS business grows and acquires more customers?

Growing a SaaS business requires additional expenditure and CAC costs may become higher. For example, in the second month of the year our cloud-based storage company acquires an additional five customers. This would mean that the cash flow trough will multiple five times in the second month, ultimately presenting a higher loss.

The positive side is that the cash flow trough doesn’t last forever. Positive cash flow should occur around 12 months after launching any SaaS business and as SaaS writer, David Skok highlights:

“The faster the growth in customer acquisition, the better the curve will look once it becomes positive”

Five Steps to Managing SaaS Cash Flow Effectively

Experiencing negative cash flow doesn’t mean the end of your SaaS business; for most, it’s just the beginning. However, if you need a few pointers, follow these five steps to managing cash flow more effectively.

1. Cash flow vs profits

Are you truly aware of how much money is coming in and going out of your company? It might be tempting when you’re launching a new business to focus on how much money you’re putting into your pocket. However, concentrating solely on profits is a big no-no. Business owners should be actively measuring and focusing on cash flow instead of profits, and be able to use cash flow to give an accurate figure of their business’ financial health.

2. Incentivize annual payments

The cash flow trough is usually unavoidable for young SaaS startups, yet it can be alleviated by asking new customers for an upfront annual payment in return for a discount or another similar incentive. This will help SaaS businesses reach positive cash flow quicker.

3. Monitor and organize incoming funds

Does your business have clear and structured payment terms? Are you sending invoices on the same day each and every month? Monitoring and being organized with receiving your incoming money from subscribers and customers is imperative to improving cash flow. Similarly, you’ll also need to know where your money is being spent.

4. Open your toolbox

There are payment analytics, accounting, and admin tools that will help make running a business easier. Many also integrate fully with your eCommerce platform of choice.

5. Find an investor

Incoming cash flow doesn’t always need to be from your customers. Get an investor for your SaaS business and quickly inject some cash into your company and give you some running room.

Cash flow is important for any SaaS business. It’s the lifeblood that keeps a company running and with two-thirds of small businesses in the United States closing within two years of opening due to insufficient credit, you’ll want to focus on obtaining positive cash flow within the first 12 months of launching your SaaS business in order to stay afloat.

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