Startup Financials - How To Manage Cash Flow
As the saying goes “cash is king,” and in the ever-changing startup world this saying is even more true. Think of cash as the fuel that powers your startup, without it you can’t go anywhere. In this article, I will walk you through what a cash flow statement is and how to use it to manage cash for your startup!
What is a cash flow statement?
A cash flow statement shows how much money is coming into and going out of a company during the statement period. There are three parts to a cash flow statement: cash flow from operating activities, cash flow from investing activities, and cash flow from financing activities. Here are some examples on what these activities are:
Cash Flow from Operating Activities: the net financial change from everyday business activities such as invoices that were collected, bills that were paid, employee paychecks that were paid, etc.
Cash Flow from Investing Activities: the net financial change from investing activities include purchases or sales of fixed assets, merger and acquisitions, market securities, etc.
Cash Flow from Financing Activities: financing activities include borrowing from a bank, issuing bonds, paying off loans, distributing dividends, etc.
Why managing cash flow matters
Internally, running out of cash is the number one reason that startups fail. Even if you are making plenty of sales, if you don’t have enough cash in the bank your startup won’t be able to pay its bills and stay open. That is when cash flow management comes to play. The cash flow statement can help you plan the best time to make a big purchase, like a new piece of equipment or a company vehicle. Monitor cash flow closely and frequently so you can spot trends and catch activities that could lead to a cash shortage.
Externally, if you are thinking about getting a loan or investment, it’s a lot easier to get help from a bank or investor before a cash crisis. If you wait until you’re really in trouble to take action, lenders may see you as too much of a risk and turn down your request. So be sure to start your loan application when you are in a good cash position, it will increase your chances of approval.
No matter what stage your startup is in, a cash flow statement can help you see things ahead and stop a cash crisis from happening.
CFO Tips on managing cash flow
Have you had this experience, your income statement shows there is net income, yet you don't have cash in the bank? There could be many different reasons, the two most common reasons are due to long accounts receivable (A/R) and inventory cycles. Here I will teach you how to utilize cash flow statements to manage your operation so that you won’t run into any major cash problems.
Get payment upfront
There is nothing wrong with asking the payment up front from clients. By asking payment upfront, you gain an insight on the willingness of the customers to pay, and you are proactively managing the cash flow to ensure your startup has the cash to survive. So let your customers know that your company asks clients to pay upfront.
Manage accounts receivable
If you have to wait to get paid from customers, make sure to manage your accounts receivable well. A/R is the money you earned but haven’t received. Remember before the money is deposited in the bank account, it is not yours, yet. Do not stop until you have collected the payment and have deposited it in the bank!
Manage inventory
Inventory is another big reason that your cash might be tied up for a while. It may be a long cycle from buying raw material, assembling them into finished products, marketing them, selling them, and collecting the payment. You need to know the time it takes from the beginning of the inventory cycle to the end. I strongly recommend founders map out the cash flow cycle for inventory, so you can plan ahead on when and how much to spend.
Manage seasonality
Seasons and holidays impact sales, fluctuating sales means more inventory is required to cover the ups and downs. If you also try to vary the number of employees to match, that costs even more cash for hiring, firing and layoffs. Bear in mind every dollar in inventory is a dollar less in the bank. You can use industry and company historical data to build the seasonality into your inventory forecast and budget and manage cash flow.
Build a buffer and plan for the unknown
Manage the risk ahead by planning for unknowns. When you’re forecasting and budgeting, it is good to have some buffer. You don’t want to be in a position where you’ve allocated every single penny, to the point where you can’t accommodate any unexpected expenses.
You can’t predict the future but you can manage it. Startup founders can’t predict the future, particularly any unforeseen expenses that might occur, for example if a piece of expensive lab equipment breaks and needs to be replaced right away, or a data breach results in a forced increase in IT spending. Part of reviewing cash flow statements is considering the impact of any potential risk, and the effect an unexpected expense will have on your available cash—and ultimately, your ability to pay your bills.
Takeaways:
By understanding a cash flow statement, founders can analyze whether the operations are generating cash, and whether inventory and accounts receivable are getting too high and absorbing too much cash as the business develops. Cash flow management helps the business to plan how much cash it needs to support the operation and avoid future cash flow problems, make sure to utilize this tool to help your startup moving forward!
