Am I burning through cash? (ask your cash flow statement)

Finally, my favourite – the Cash Flow Statement. Unlike P&L and the Balance Sheet, Cash Flow as a concept is super intuitive. Simply, it is money moving in and out of your company’s bank account, and we call that cash inflow and outflow. Positive Cash Flow means that more money is coming in than going out, and that’s a good thing.

The Cash Flow Statement is a bit more complicated than that, though, mostly because it categorises the money going in and out into three buckets: Cash Flow from Operations, Cash Flow from Investing, and Cash Flow from Financing. These figures are always shown for a particular time period (say, the year 2019).

Say you have a beauty brand, and you’re selling face creams.

Cash Flow from Operations is cash from all your business activities. On the inflow side, that’ll mostly be money collected from people who buy your creams; on the outflow side, it’ll be what you paid your suppliers (for the pots and the lids and the ingredients, etc.), your employees (their salaries), and anything else that you paid to keep the business running. The resulting difference should be a nice, healthy, positive number. Some go as far as to say it’s “the single most important number indicating the health of the business”. (1)

Cash Flow from Investing is mostly relevant if you make any capital investments, like buying a factory or machinery. This is, obviously, cash outflow (money out), and most companies don’t have cash inflow from investing. Therefore, it’s quite normal for the cash flow from investing to be a negative number; or it can easily be zero if you didn’t make any capital investments.

And finally, Cash Flow from Financing is whatever money is coming in and out because of loans you took out and equity investments such as venture capital (VC). If you paid $20K in loan repayments, that will show as an outflow here; if you got $500K in VC money, it will show as inflow. The difference, net cash from financing, will be $480K. Again, if you didn’t do any of this, that number will be zero.

When you add up these three things, the resulting number will tell you whether the company was building or using up its cash reserves during this time period. If the overall Cash Flow is positive, it’s the case of the former – if it’s negative, it’s the latter. Positive Cash Flow is always a good thing; negative can be fine if it’s the result of a company cleverly investing in things that will make it more successful (and more profitable) in the long run like building its own factory, for example, or it can mean trouble, depending on the context. Because of this, Cash Flow from Operations is a better indicator of how healthy a company is than the overall Cash Flow.

Looking at a Cash Flow Statement is kind of like looking at a company’s bank account, only better, because it also shows you what kind of activity the cash is coming from, and where it’s going, rather than just the fact that it’s coming and going.

Why do we need this in addition to P&L and the Balance Sheet? Precisely because neither of these show us cash movements. You may have a profitable company and still be running out of cash. The opposite can also be true – you may have cash but not be profitable. Together, they paint the whole financial picture.

Love and cash flow,

Jana

(1)  Quoted from Financial Intelligence for Entrepreneurs, an excellent, excellent book by Karen Berman and Joe Knight. If you only ever read one finance book in your life as a founder, make it this one.

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