Finance might not be the reason why you founded your startup or early-stage company, but it is critical to helping the business grow. With our blog, we’re hoping to bring founders and business owners closer to finance, and this one is no exception.
A few months ago, we took a brief look at the Basics of Business Finance. This month, we’re expanding on one of those – cash flow and cash flow statements.
Why Cash Flow Matters
As a startup founder or a business owner, you don’t need a finance degree to help your company thrive, but it is important to stay on top of your figures. The most important one to monitor is cash because without enough of it you are dead in the water. Cash flow statements measure what you have spent over time. They summarize the amount of cash (I include bank accounts in this) that has entered and left the company over a specific period. Once you understand what you are spending money on from week to week, month to month, or over the full cycle of a year you start to realise how you can control those flows to steer your business.
Cash equivalents are assets your business owns that can be converted into cash immediately. Bank accounts count as cash equivalents, for example. Shares or trading stocks are not cash equivalents because their value can fluctuate and you cannot change them back into cash immediately.
You can choose to look at your cash flow statement over a month, a quarter, or a year. The most important thing is that you look regularly. If your business has only just been established, it’s worth checking your cash flow more frequently as unless you are very lucky this is when cash is likely to be at its tightest.
Especially if your business is still very small or very new, you may think that you have a good grasp of whether you are making more money than you are spending, and how you might fill any gap. However, as the business grows even a little, cash flow becomes harder to manage. The expenses you have may no longer be instant. Instead, you may have bills to pay quarterly or even annually, which makes keeping track of cash more complicated.
Here is some of the information you can quickly gather from a cash flow statement:
- The amount of cash on hand during the period you’re analysing. Was it what you were expecting?
- The sources of your income: was it sales, loans, and overdrafts, or were you selling shares in the business?
- What that income was spent on. Running costs, investing in assets for the business, or something else?
It might sound like your cash flow statement is similar to your income statement or profit and loss. But there is a crucial difference: cash flow statements are harder to manipulate. Income statements can include depreciation, which is not a true outgoing of cash. Depreciation simply allocates the cost of an asset over its lifespan.
What Cash Flow Tells You
Cash flow statements are like a health check for your company. If the business is growing rapidly, you will be able to assess whether that growth is making your business unstable. More mature businesses tend to grow at a slower rate.
Cash flow is either positive or negative. If your cash flow is positive, you are making more money than you are spending. A negative cash flow indicates that your business is currently spending more than it is generating. This may sound scary, but uneven cash flow is normal for newer companies especially if you are investing in future activities by buying equipment, or spending or marketing to drive future business.
For example, you may have one month with a high level of income and another month during which your expenses are higher. Negative cash flow might be a warning sign but not always. You want to make sure you select a period that lets you draw meaningful conclusions. In many cases, looking at a quarter rather than a month works better.
The Foundation of Solid Business Decisions – For You and Your Investors
Understanding your cash flow is the foundation of solid business decisions.
If you are thinking of expanding or buying new equipment, cash flow will impact your budgeting. Knowing your cash flows will also help you decide whether you can afford to hire new staff. If your business is large enough to support individual departments, your cash flow statement lets you see who is contributing the most.
Potential investors will also want to examine your cash flow. In fact, it is often a deciding factor for them. Some conservative investors consider uneven cash flow too risky. Others are attracted by the opportunities a fast-growing company offers.
How to View Your Cash Flow Statement
Building a cash flow statement is simple with the right tools. Bookkeeping and accounting software like Xero allows you to create a cash flow statement whenever you need it.
There’s no need to pore over difficult spreadsheets. Comparing various time periods is quick and simple even for those owners and founders who are not particularly finance-minded. What’s more, when your accounting team or potential investors want to review your company’s financial health, the information is there at your fingertips.
Making Sense of it All
Positive cash flow statements are an excellent indicator of the financial health of your business. However, on its own, your statement of cash flow does not provide the full picture. Your company can have positive cash flow without making a profit, for example.
To assess the whole picture, it is best to consider cash flow alongside your profit & loss statement and your balance sheet. Both of those highlight transactions you have made, even if the money has not yet changed hands. All three are the most important financial documents for any business.
Gaining basic financial insight is the basis for growing and scaling a small business into a larger, more successful entity. You will simply make smarter decisions.
Still not convinced about understanding your cash flow statement? Don’t hesitate to contact us for more information or a chat about your startup’s financial health.