Startup Cash Flow Management
AUGUST 18TH, 2017
The most important activity facing any startup company is cash-flow management. Successfully managing cash-flow allows the company to reliably forecast operating budgets, and invest excess cash to fuel growth.
Cash flow is very simple; it’s the amount of cash a company either produces or consumes in a given period. In a cash-strapped situation, cash should be monitored weekly or daily basis; this period can be lengthened as the company’s cash position improves.
The profit of a business is the difference between revenues and expenses. If revenues are greater than expenses, your business is producing a profit. If expenses are greater than revenues, your business is producing a loss.
Many people confuse cash generation and profit generation. There are many examples of profitable businesses that don’t generate sufficient cash, and conversely, there are many examples of companies operating at a loss, who generate significant positive cash flow. Revenue and expense recognition and capital purchases can distort the relationship between profit and cash.
Cash Flow Statements can be confusing to calculate, but are fairly simple if you take it one section at a time. Remember that your ‘check’ is your bank balance at the beginning of the period versus your bank balance at the end of the period. If you start the period with $1 million in cash, and end the period with $500k, your cash flow for the period is negative $500k.
To calculate the cash flow statement, start with Net Income as your base. Then start at the top of the balance sheet, and work your way through the line items. Current assets consume cash if they increase. For example, if your Accts Receivable balance increases, you’re customers may be taking longer to pay you, thus you’re not generating cash. So, if your current assets increased, subtract the amount of the increase from Net Income, and if they decreased, add the amount to Net Income.
Next, look at Long Term Assets. If they have increased, you subtract that number from your Net Income, and if they’ve decreased, add the amount to Net Income (just like we did with Current Assets). Long Term Assets will increase upon the purchase of Property, Plant, and Equipment or Intellectual Property, etc. All of which you must spend cash to acquire.
Now we move to the Liabilities section of the Balance Sheet. The rules flip in this section, so do the opposite of what you’ve just done with the Asset section. As an example, Current Liabilities could increase because you’re establishing better credit terms with your vendors, thus Accounts Payable increases; meaning you’re not paying out cash as quickly.
Next, look at Long Term Liabilities. Again, add any increase to Net Income, and subtract and decrease. Increases to Long Term Liabilities typically occur when the company takes on a bank loan. Conversly, Long Term Liabilities decrease if the company pays off a bank loan early.
Our last section is Stockholders Equity. First, remember that you need to back out the current period’s net income because we’re using that as the basis for our calculation. Basically the only reason Stockholders Equity would go up would be an equity raise, which contributes cash to the company. Thus, any increase in Stockholders Equity must be added to Net Income.
Again, you’ll want to check this against the cash balance at the start of the period and the end of the period to make sure that your calculations check out.
This analysis can help identify business weaknesses, for example, let’s say that you find your accounts receivable are too high; you can hire a dedicated collections person, revamp your credit terms, etc. Conversely, if your being squeezed by vendors, you may want to re-visit your payable terms, and work out a more cash-friendly situation.
Cash Management is key to growing a successful business. Metrics like burn rate, and months remaining (given burn rate) are vital pieces of information, and can be discerned by formulating the cash-flow statement, and analyzing trends.
