In the business world, and especially with startups, cash and cash management determine which endeavors succeed or fail.
Cash flow is a simple concept, but it’s not always easy to understand.
Your startup’s cash flow statement can say a lot about what’s happening in your business. Understanding how to read and gather insights from the report helps you weather the challenges and stay abreast of critical business issues.
What is a Cash Flow Statement?
The cash flow statement gives a clear picture of how cash moves through your startup during the reporting period.
When you see in the statement of cash flows which activities generate (or consume) cash, the decisions you need to make become clearer. You know where to focus your team’s effort and attention.
The cash flow statement is divided into three sections:
- Operating activities
- Investing activities
- Financing activities
Operating Activities
This term shows your startup’s cash flows coming through normal business activities.
For example, a SaaS business will generate cash through sales and subscriptions and a product business from product sales.
But because it costs money to deliver your products, you also have cash going out. Examples of these costs include cash payments for materials or salaries.
Investing Activities
There is a wide range of activities falling into this category.
Typically, these activities create future benefits for the startup by purchasing or selling assets like a server room or manufacturing space.
But investing activities can also refer to intellectual property or marketable securities, like patents or commodities contracts.
Financing Activities
Cash flow from debt or equity financing belongs under the financing activities.
Outflows might come from the repurchase of common stock shares or by dividend payments to shareholders.
Inflows come from any financing activities, like issuing debt or selling common shares in the company.
Calculate your Cash Flow
There are two standard methods for calculating your startup’s cash flow: direct and indirect.
Direct
A business’s direct cash flow calculation uses transactional information from bank accounts and accounting tools. You add all cash collected from your operating activities and subtract all cash disbursements.
Although this sounds simple, and for smaller companies, this method is often less preferred in larger companies.
Indirect cash flow
As the name implies, the indirect method indirectly calculates the cash flow.
Once a business is large enough, it must switch to accrual-based accounting. Accrual-based accounting means expenses and revenues are recognized when goods or services are delivered, not necessarily when cash is received.
To determine the cash flow for the period using the indirect method, start with your startup’s net income. Then, make adjustments to remove non-cash transactions like accruals, depreciation, and amortization.
Positive and Negative Cash Flow
While profitability is a key indicator of a healthy startup, operating income doesn’t always translate to positive cash flow. It’s possible to be profitable without being cash flow positive and cash flow positive without showing profit.
If your startup is funded, negative cash flow means your runway is getting shorter each month. You’re spending more money than you’re taking in, so it’s essential to understand what’s happening in the business.
Long-term, negative cash flow can be disastrous. However, as long as you understand what’s behind the negative cash flow and are monitoring it appropriately, your startup isn’t doomed.
Short-term negative cash flow can be caused by a high level of investment in business growth or restructuring.
Line Items to Know
A cash flow statement bridges your startup’s cash position from the beginning of the period to the end.
There are a few items commonly found on a cash flow statement that every startup founder should be aware of:
- Net Income – shows the profitability of the company during the reporting period
- Cash generated by operating activities – the money consumed or generated through regular business activity
- Payments for the acquisition of plant, property, and equipment – investment in your startup’s growth through expanded facilities or capacity.
- Payments for the acquisition of intangible assets – often refers to purchased patents or technological know-how.
- Dividends paid – cash paid to shareholders in the form of a dividend
- Sale or repurchase of common stock – cash generated through selling (or buying back) company shares
- Issuance of long-term debt – cash received in the form of a loan
Get Startup-Focused Reporting
Turning an operational profit is essential and signals your startup’s ability to finance ongoing operations and growth. If your startup isn’t yet profitable, you should work toward profitability.
But profitability isn’t the only thing.
Managing your startup’s cash flow might be just as critical. Running out of cash can cause your operations to come to an abrupt halt.
To stay on top of your business’s cash flow, you need solid reporting of all your financials. You also need in-depth analysis to understand both what’s driving your cash inflow and what’s draining your resources.
Founder’s CPA can set you up with the startup-focused reporting you need to make critical decisions.
Get in touch with us at Founder’s CPA for a consultation on how to get started.
