The Cash Flow Statement - What Really Matters:
One of the most important tools and statements as your startup grows, the Cash Flow Statement is a financial report that provides a clear and concise overview of the cash inflows and outflows within your startup during a specific period.
Unlike the Income Statement which includes non-cash items such as depreciation of assets, the Cash Flow Statement focuses solely on cash transactions, making it a significant tool for understanding your startup’s liquidity and financial health.
It is useful for founders to prepare the Cash Flow Statement on a quarterly and annual basis, however, a monthly breakdown will allow you to drill into your data to check the financial health of your company and make informed decisions.
Before diving into how to prepare the statement, let’s dig into the three key components that make up the statement:
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Operating Activities: This section captures the cash flow resulting from your startup’s core business operations. It includes cash received from customers for sales and services, as well as cash paid to suppliers or employees for operating expenses.
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Investing Activities: Here you’ll find the cash flow related to your startup’s investments in assets. It includes cash outflows for purchasing new equipment, money spent towards building your software or IP, as well as cash inflows from selling any assets.
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Financing Activities: This section accounts for the cash flows related to your startup’s financing activities. It includes cash received from potential investors when completing a capital raise via equity or debt, cash received from lenders, or any cash repayments to debt obligations.
Preparing the Cash Flow Statement:
To begin, you start with your cash balance at the opening period of your statement. For example if you are preparing a cash flow statement for your year end December 31, 2022, you take the closing cash balance as at December 31, 2021.
With that, we breakdown the statement to the three components above:
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Operating Activities: Summarize all cash received from operations (revenues), and cash paid out for operating expenses. It would be useful to break it down between revenues, cost of sales, and operating expenses, to give stronger insight for readers.
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Investing Activities: Account for cash flows related to your startup’s investments.
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Financing activities: Record all cash flows connecting to financing your startup, such as inflows from capital raises or debt received/paid back.
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Calculate Net Cash Flow: Sum up the cash flows from the three components to determine your net change in cash in the period.
Lastly, the sum of your net cash flow and your starting balance will result in your ending cash balance for the period, which will tie into the cash balance on your Balance Sheet as of the closing date.
See below for a cash flow statement:
Why is the Cash Flow Statement an Essential Tool?
The Cash Flow Statement offers invaluable insights into your startup’s financial performance and sustainability. It is also an important financial statement to have prepared for startups looking to raise capital from potential investors.
Here is why:
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Assessing Cash Position: Cash is king for startups from inception to scale up. The Cash Flow Statement enables you to gauge whether your startup has enough cash to cover day-to-day expenses and meet financial obligations such as any debt servicing or upcoming payments to vendors or employees.
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Identifying Cash Flow Trends: Both founders and potential investors can analyze the cash flow from different periods to help plan for future cash needs, identify potential cash shortages, as well as to determine where costs are the primary cause of outflows
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Evaluating Operational Efficiency: Understanding the cash flows from operating activities reveals how well your startup manages its core business operations. Insights on costs associated with financing operations and the revenue level that must be brought in to achieve profitability.
A few metrics that investors will utilize the Cash Flow Statement for will be to analyze the startup’s burn rate as well as the cash runway. As a founder, keeping track of this will ensure the survivability of the company as well as planning out when the company will need to fundraise.
The burn rate refers to the rate at which a startup is spending its cash to cover operating expenses and investments. Using the Cash Flow Statement, you can determine your burn rate on a monthly and annual basis to determine your burn rate.
Cash Runway is the estimated length of time your startup’s existing cash reserves can sustain its operations without additional funding.
For a startup, these two metrics will be analyzed hand in hand using The Cash FLow Statement by potential investors for several reasons:
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Financial Viability: VCs want to invest in startups with a clear path to financial sustainability. A reasonable burn rate couple with sufficient cash runway reassures investors that your startup can weather challenges and make meaningful progress.
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Milestone Achievement: VCs look for startups that can achieve important milestones with their cash runway. This can be revenue or customer targets that can be achieved with the current burn rate and cash runway.
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Mitigating Investment Risks: Startups with a longer cash runway reduce the risk of failure due to sudden cash shortages.
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Strategic Planning: Understanding your burn rate and cash runway enables you to plan your business strategy more effectively. IT can help guide decisions on how much cash to burn to achieve certain growth milestones and ensure proper allocation of resources. Since it could take several years for startups to turn a profit, the burn rate and cash runway provide critical insights as to how much funding a startup will need, as well as when it will need that funding.
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Both founders and investors look to strike a balance between cash burn and growth. With high levels of cash burn, there should be positive signals that support the spending, such as high user growth or R&D to improve the product to lead to stronger monetization or gross margins.
As an entrepreneur, the Cash Flow Statement can significantly impact your startup’s journey to success both for operations as well as when beginning to plan yourthat capital raises. It can assist in assessing the company’s financial health, potential for growth, and ability to manage resources and navigate challenges.
Suggested Prompts
How can startups effectively use the cash flow statement to identify and address potential liquidity issues before they become critical?
In what ways might analyzing cash flow components differ between startups at different stages of growth or industry sectors?
How can integrating the cash flow statement with other financial statements improve strategic decision-making for founders and investors alike?
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