Cash has always been a common topic of discussion among investors and founders, and it is only getting louder. In this jittery economic environment, understanding the nitty-gritty of your cash flow situation and being able to present it to investors in the right light can be a matter of survival.
The importance of a cash flow statement should not be underestimated. An accurate and well-presented cash flow can ensure that your spending is efficient, guide you in identifying how much to request from investors, and, ultimately, make the difference in whether or not you receive the money. In other words, how you approach your cash flow can make or break your early-stage company.
If you’re new to the game, however, coming up with your inflows and outflows may feel like taking a stab in the dark, which doesn’t instill much confidence when you need to incentivize investors to fund your business.
Since Waveup helped more founders with their financials and other pitch deck materials, we can shake a stick at, we are more than familiar with this issue. In this article, we will walk through the following aspects of cash flow:
- What is a cash flow statement? How is it calculated?
- Why cash flow statement is important for startups
- How to make your cash flow figures more attractive to investors
What is a cash flow statement?
The cash flow statement is the bedrock of your financial model and the heartbeat that keeps your business alive. It helps you understand how much free cash your business has, why it’s there, and what you can do with it. The cash flow statement is broken down into three sections: operating activities, investing activities, and financing activities.
Operating cash flow is the amount of money your business generates after delivering its regular goods or services.
Investment cash flow is money that comes from buying and selling business assets. This includes physical assets – equipment, vehicles, buildings – and intangible assets like licenses, trademarks, and patents.
Financing cash flow refers to how a firm raises capital and pays it back to investors, including paying cash dividends, adding or changing loans, and issuing and selling more stock.
By calculating amounts for these three categories, you can determine your cash flow’s bottom line (i.e., the net cash flow) for each period.
There are two ways to calculate your net cash flow:
- Direct method – making short-term projections (usually up to 90 days) about your cash flow using previous transactions
- Indirect method – projecting how your strategic plans will impact your bank balances in the long term
Either method takes some accounting magic at the start, but it’s smooth sailing once you establish the process. We recommend that startups keep up with their cash flow monthly, just as they do with other financial documents like P&L statements or balance sheets. These documents provide different information and can only be interpreted together.
With the boring theory out of the way, let’s get to the juicy part, where we discuss why the cash flow statement is so important for a new business model and for your fundraising efforts.
Three key reasons why cash flow is so important for startups
Think of it this way: if cash is the king, then the cash flow statement is the hand of the king – the king’s closest advisor. The statement puts your cash flow in context and reveals things you wouldn’t see or predict just from your P&L statement or balance sheet. This, in turn, helps you make more effective decisions when it comes to business and fundraising.
1. A cash flow statement is a crucial instrument in your fundraising efforts
One of the reasons why cash flow is important for fundraising is because investors care about it. When they look at your startup’s financial prognosis, they will scrutinize your cash flow the most. Why? Because it reveals three things:
- Your real cash needs
- Your financial health
- Your potential
Cash flow can demonstrate to investors whether your company needs to fill a funding gap to fuel its growth. Additionally, a neat cash flow can prove to investors that your business is financially sound, that you are on top of your finances, and that you won’t immediately burn through the money they give you.
FYI: No one expects the numbers to be perfectly accurate (they never are). What investors do expect to see is that you know the nuts and bolts of your accounting and that you’re capable of being cost-efficient with their precious money.
2. A cash flow statement reveals upcoming cash shortfalls
Before the funding round ends, 38% of startups will die from burning through the money too quickly. How do you ensure you won’t follow in their footsteps? You guessed it – by regularly budgeting and keeping up with your balance sheets.
The main importance of a cash flow statement lies in the fact that it reveals potential problems or poor decisions that can shorten your runway. You can see how delayed payments from customers, renovations, expensive licenses, unexpected upfront payments, or new Macbooks affect your cash burn, enabling you to take action before these challenges grow into massive cash shortages.
3. A cash flow statement helps to unearth hidden cash reserves and opportunities for savings
When the economy is in shambles, a “growth at all costs” mentality doesn’t cut it. When giants like Meta and Twitter have to resort to massive layoffs to cut spending, it is a no-brainer for investors to expect severe frugality from early-stage startups. To raise the round and survive it, prepare to play by the rules of bear markets and be efficient with cash.
Examining your cash flow will reveal the hidden reserves into which you can tap if the money situation becomes dire. It will show you what assets you can sell without harming the business and what expenses to cut to stay afloat. The ability to be frugal and capital efficient is appreciated by investors, even when the economy is peaking. In light of the upcoming recession, this is simply vital.
Key cash flow metrics to track at all times
Here are some metrics to keep tabs on and a few bits of financial wizardry from the Waveup team that can help you to raise your next round.
Investment in Working Capital
Working capital (WC) is the difference between your current assets (cash, accounts receivable, and inventory items available for 12 months or less) and your current liabilities (your accounts payable and other money you owe within 12 months).
The WC number itself is a balance sheet item. A change in this number, however, is one of the fundamental cash flow items that determine how much money you need. Growing and scaling a business usually requires new assets and liabilities. You will naturally need resources to keep and cover them, which potentially impacts your funding needs.
Remember, having a negative working capital doesn’t always mean that your business is in trouble or needs urgent investments. For example, large tech companies operating on a SaaS subscription model often have negative WC. Why? Because these companies receive upfront payments from customers in the form of annual subscriptions.
With these upfront payments, businesses receive additional resources, which may shrink the sum of needed investments for a while. At the same time, this business has to record a deferred revenue liability until the service is performed, which increases current liabilities. Voilà! That’s how the negative WC appears.
Cash Flow gap
If you Google the definition of cash flow gap, you’ll see that many define it as the length of time between your payables and receivables.
In our financial models, however, we treat it more like a funding gap, or the amount of money a business lacks to be able to operate for a certain period of time. Therefore, when we look at the cash gap, we see how much investment your business needs.
Let’s illustrate this notion with a close-to-home example. You are a plumber who needs to buy a fancy screwdriver costing $50, but you only have $30. The cashier will sell you the screwdriver if someone brings the remaining $20 within three hours, and you have to stay in the shop in the meantime. So there you are, waiting for someone to drop off the dang money, unable to do your work.
If you are a business in this story, doing nothing (aka “downtime”) essentially means death. It means bankruptcy. That’s why companies take loans, fire people, or slow down their growth when they see a cash flow gap. The gap is a mathematical indication that your startup will be in trouble with the existing resources and obligations in a certain number of months.
That’s why it’s essential – whether you are a new business or established – to track your cash gap and find timely solutions if the gap is significant and/or if it increases. Just remember that your accounts receivable/revenue might not convert into cash for some time due to a range of expenses, therefore make sure to find other sources to fill this gap.
To make sure that your funding ask isn’t lower than it should be and that you’ll have enough money to survive your runway, pay close attention to your future capital expenditure – or CAPEX.
CAPEX is the money that goes into acquiring, upgrading, or maintaining fixed (or long-term) assets. Fixed assets can be tangible (e.g., vehicles, technology, offices, and equipment) or intangible, like patents or licenses.
When founders estimate their needs, they tend to forget that their CAPEX (just like their OPEX) isn’t set in stone and will, in fact, grow with their business. Equipment or facilities tend to break or become outdated over time, and you’ll need money to replace or renew them. If you don’t consider this when making your estimations, you might end up raising less money than you actually need.
Therefore, you should always compare your year-by-year CAPEX against the average industry percentage and factor in potential repairs and fixes, license renewals, and other costs that will arise over time.
Know your numbers!
Your startup cash flow statement is the bedrock of effective financial planning and successful work with investors. You turn to it to understand how much money to raise, how long this money will last you, how your actions affect your short-term and long-term balance sheets, and what to do about it.
As a startup expecting to raise a round in times of recession, your priority is to keep your burn rate as low as possible. And the first step is to know your month-by-month cash situation inside out.
Here are a few tips to make your cash flow statement for a startup more accurate and compelling for investors:
- Conduct monthly or bi-weekly forecasts to keep tabs on your runway and to quickly identify risks and opportunities for savings.
- When projecting growth, don’t forget about the related expenses.
- Keep tabs on your working capital, learn to understand what the numbers mean for your business, and make decisions in accordance with that understanding.
- Track your cash flow gap to understand how much time (and money) your business has before it starts scraping for pennies, and base your funding ask on that knowledge.
Feeling overwhelmed by the intricacies of building a financial model? Check out Waveup’s best financial modeling practices that have helped our clients to raise over $1.6B in funding.