I've heard that it's rather common to be technically profitable (i.e.: a company has a greater income than expenses), but nonetheless insolvent due to bills coming due before clients pay their invoices.

From what I was told, this mostly affects supply-chain heavy companies; software companies are mostly spared this kind of consideration.

What are some of the red flags that founders should be aware of when reading their own cashflow statements?

No, this also affects software companies, especially those that grow faster than you would organically. The cost in software companies is a cost in people. These people need to be paid. If you are not paid in advance for your software, then you have a cash flow issue: you need to have enough reserves to bridge the gap between paying your developers and you getting paid for your outgoing invoices.

Think of it like this: if you are providing a service, but are not getting paid for this in advance, you are essentially giving the customer a short term loan. You cannot infinitely provide those short term loans considering that you have bills/salaries to pay. It might still be money that belongs to you, but if you do not have it in your bank account when your bills are due, you are insolvent.

Things to be very wary of when looking on your balance is having very low ratio of liquid cash in respect to your debtors post (e.g. unpaid outgoing invoices). This means that if your debtors are going to pay later than expected, you have very little runway to cover that. Now, what risk this poses to your company depends a lot on how many customers you have, whether they pay their invoice automatically, and what their history of late payments is. Furthermore, the same applies for you on the purchasing side: if the majority of your costs are on the purchasing side and you can afford to pay those bills later without getting your servers shut down, then being illiquid is less of a risk. If the majority of your costs is in employees, then you are in trouble: not paying employees is a big no-no, so that increases risks and allows for less wiggle room.

I'm currently handling bookkeeping for software companies and one thing that's often overlooked is your clients consistently making late payments on their invoices. Make sure that you know who those client are and schedule accordingly.

DSO (Days Sales Outstanding) is one of the most important numbers to track for any company. If you are a small company it is arguably the most important one to manage cash flow

And it is a notoriously fickle metric, most people track it at month end, and yet their main sales receipts come in after... leading to a rather alarming result. DSO or debtor days as it is often called in the UK, needs to be read with an understanding of the payment patterns in that business.

In the UK the big risk is sales tax (VAT). It needs forecasting on top of sales receipts, and every quarter you have to pay this sum you have collected over to the exchequer. VAT is notorious for taking down businesses who spent the receipts!

Otherwise you should model what happens when the sales come late or not at the level you want, Braintree hold your cash, etc. If you can't flex your overheads to stay within your cash facilities, then you are risking insolvency.

Sales receipts, payroll and sales tax are the big numbers.

It seems like modeling could help get an idea of the size and frequency of each cash shortfall and thus inform how large a short-term credit line you needed?

Indeed negotiating a line of credit often requires a model.

Hi @jimnotgym, [Using a throwaway account] We built an active cash flow management tool to bridge the gap between finance and non finance people. We would love to hear your feedback on our product. Can you help?