Business Process Management

How to Manage Cash Flow in a Subscription Business

May 26, 2023

According to a U.S. Bank study, 82% of business failures are due to poor cash management. While there are numerous contributing factors for this significant figure, some of the most common reasons stem from the unknown. These include unanticipated dips in product and software demand, unexpected expenses or expenses that were higher than anticipated, and increased customer churn. Aside from fulfilling consumer or business needs, the goal of any business is to ensure a healthy cash flow – one where revenues consistently exceed expenses. A subscription business can enjoy many cash flow advantages, but knowing how to manage the ebbs and flows is key.

Cash Flow: What it is and why it’s Important

Consisting of money received from sales, as well as money spent on expenses; cash flow is the amount of cash that comes in and goes out of a company. Frequently confused with profitability, the terms carry different meanings. Cash flow refers to the amount of cash that enters and leaves the business over a specific period of time, whereas profit doesn’t adequately represent the financial standing of a subscription business.

In fact, since profits can include non-cash items such as expenses due to depreciation or goodwill write-offs, it’s entirely possible for a company to report profits but still be in jeopardy of going out of business. For example, let’s assume that your subscription-based software business offers customers the option to be invoiced monthly, quarterly, or annually. While on paper the company appears profitable, until payment is received the subscription business may be operating in a deficit and can even find themselves in a position where they are unable to meet financial obligations.

Considered to be more important than profitability, cash flow provides the financial information needed to ensure you can meet current and future financial commitments. It provides an accurate view of how much money is entering and leaving your business, not the amount of money you’re waiting on from accounts receivable (AR).

Challenges of Negative Cash Flow

Managing cash flow is one of the biggest challenges a subscription business – large and small – faces. Without proper cash flow management, you may find yourself facing negative cash flow. This has both internal and external repercussions like:

  • The inability to pay employees or suppliers
  • Being unable to cover the subscription business’ rent/mortgage, utilities, and insurance
  • An inability to purchase needed assets
  • It can even damage your company’s reputation and brand trust

This is certainly not a situation any subscription business wants to find themselves in, however it happens – even to industry-leading organizations. Two prominent companies with household names – The Home Depot and Nike – faced negative cash flow during periods of critical growth.

How to Calculate Cash Flow

Before discussing how to calculate cash flow, let’s look at the three main business activities a cash flow statement covers.

Cash flow from operating activities (CFO): Associated with standard business activities, operating activities include inflows of cash like revenue from sales, interest and dividends received. This includes cash outflows such as mortgage/rent payments, salary payments to employees, payments to suppliers, and income tax payments.

Cash flow from investment activities (CFI): Money either gained or lost through short- and long-term investments. These can be the purchase of physical assets, investments in securities or the sale of securities or assets.

Cash flow from financing activities (CFF): Represents finance activities, including the issuance and repayment of equity, payment of dividends, issuance and repayment of debt, and capital lease obligations.

Calculating cash flow isn’t complicated. There are three primary cash flow categories to know – net cash flow, operating cash flow and free cash flow. Cash flow tracking methods depend on your specific accounting goals. For example, your cash flow analysis could be for operations managers, outside investors, both, or others.

Cash Flow Formulas

  1. Net cash flow: Initial cash balance + net cash inflows – total cash outflows
  2. Operating cash flow: Operating income + non-cash expenses – taxes + changes in working capital
  3. Free cash flow: Net operating profit (after taxes) – capital expenditures

Knowing and managing your cash flow is critical for the growth and continued sustainability of any business. However, depending on the industry and business model, some organizations have an easier time maintaining a healthy cash flow. As mentioned earlier, a subscription business has an advantage when it comes to sustaining a healthy cash flow.

Cash Flow Advantages for a Subscription Business

Since a subscription business offers products and services on a recurring basis, they benefit from a steady stream of revenue. This concept is commonly referred to as compounding cash flow. Compounding cash flow refers to the incremental recurring revenue received from subscribers.

Let’s assume that in 2020, 200 customers signed up for your software. In 2021, an additional 300 prospects become subscribers. In 2022, you gained an additional 275 customers.

The incremental addition of customers and the recurring revenue received provides your subscription business with compounded revenue. This means that payments (cash flows) grow over time, providing for a predictable and reliable revenue stream. Cash flow benefits for subscription-based businesses don’t end there.

Top 7 Advantages of Cash Flow Management

  1. Improves revenue forecasting: The predictable revenue received allows you to start each fiscal year knowing how much revenue you can anticipate. This predictability provides a solid foundation for long-term planning and growth.
  2. Increases valuation: Unlike transaction-based businesses, recurring revenue provides a steady stream of cash that improves the valuation of your business. This makes it more attractive to investors.
  3. Reduces customer churn: Given the inherent repeat business associated with subscription-based businesses, you’re able to develop deeper and more personalized customer relationships. This leads to long-term loyalty and higher customer lifetime value (CLV).
  4. Lowers customer acquisition costs: With a committed customer base, less time and money needs to be spent on acquiring new customers, which over time equates to significant cost savings.
  5. Decreases cost of sales: Similar to the advantage above, the amount spent on sales efforts are less since customer relationships aren’t a one-time transaction.
  6. Improves expense management: By having a predictable and reliable revenue stream, you’re better able to estimate the amount of money flowing into your subscription business. This helps to manage expenses more accurately and cover unexpected costs.
  7. Allows for greater product/pricing flexibility: Leveraging market trends and customer feedback, subscription-based businesses have the agility to adjust/create new product bundles and pricing models quickly and easily.

Additional Considerations for Your Subscription Business

While these are the key benefits received by subscription-based companies, there are ways to further optimize your cash flow. For instance, customer retention is critical and keeping the lines of communication open with subscribers will help to build and sustain compounded cash flow. Be sure to send invoices promptly. It’s essential to quickly follow-up on past-due accounts if you don’t receive payment.

There are other areas of focus, like offering varying subscription options, product bundles, pricing tiers, and payment frequencies. You can also practice up-selling and cross-selling to existing subscribers. You need to know what your target market wants in order to meet their needs.

This is where monitoring metrics is key to understanding the financial health of your subscription business. At a minimum, be sure to track customer churn rates, customer acquisition costs (CAC), average revenue per user (ARPU) and CLV. Want to know more? Dive deeper with these 4 tips for projecting cash flow and the cash flow benefits your subscription-based business can receive.

Simplify Cash Flow Management

A methodical approach to cash flow management can help to ensure your cash flow remains positive. To consistently optimize your subscription cash flow, technology can give your company the added boost required. Billing solutions like BillingPlatform provide a flexible and scalable platform that enables your subscription business to monetize all revenue opportunities, while reducing churn by delivering frictionless customer experiences.

Our complete solution supports all your business requirements, any product, any service, any billing model, and any pricing tactic. BillingPlatform provides subscription-based companies with full quote-to-cash lifecycle support of the billing and monetization processes. From product setup, quoting, billing and invoicing, revenue recognition, to payment and collections – all on a secure next generation cloud platform.

Our solution gives subscription-based organizations the power to transform raw data, from any source, into real revenue potential. Plus, it all happens in real time. With us as your partner, you gain the freedom to run your business with the efficiency, accuracy. You’ll have the control you need to manage your cash flow effectively.

Does that sound like something you could benefit from? Then contact our team of experts to learn how we can help today.

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