Anyone who has been running their own start-up business for a little while will understand their financial position can be precarious at the best of times.
As a smaller business outfit, your finances can be extremely tight, and you have to be very careful that you are properly using your company’s finances to properly benefit its overall growth and development. In fact, this is something which is true even if you have secured lots of financial backing; financial mismanagement can be fatal to new start-ups of all sizes and even all the money in the world doesn’t make you immune from financial problems.
If you aren’t keeping a watchful eye over your company’s finances and expenses and you are not accounting for every penny spent, you are more likely to run out of money and go bust. With start-ups accounting for the largest proportion of business failures, this is not something to be taken lightly.
Knowing what your cash flow is and how to calculate and manage it is a key part of running your company. It’s not something you can ignore, and you need to have a handle on it from your very first day of operation.
What is Cash Flow and How Can I Calculate It?
Cash flow is defined cash or cash equivalents which the company both receives and gives out as payments to creditors. Cash flow analysis is used to determine the liquidity position of a company and it gives potential investors an idea of the amount of cash coming into and leaving your business. This can be analysed over time to determine growth potential.
It is easily calculated by subtracting your cash balance at the beginning of a given period of time (i.e. your opening balance) from the cash balance at the end of it. Some companies work out their cash flow on a month-by-month basis, whereas others do it per quarter or per annum.
Your cash flow balance can either be positive or negative. If positive, this means that you have more cash at the end of a period than you had at the start, and if it is negative then that means you have less cash than you had at the start. For example –
- On May 1st you had $100. On May 31st you had $50. This is a negative cash flow.
- On June 1st you had $50. On June 30th you had $500. This is a positive cash flow.
It is best to record all your company’s cash flow on a cash flow statement, so you can easily figure out where money is coming from and going to.
Although cash flow is a useful metric, it is not an ideal one and does not do much to show whether a company is making the right commercial decisions. Cash flow should be used alongside balance sheets and income statements to properly analyse a company’s financial situation.
Why Cash Flow Analysis is Important
If you don’t have cash in your business, it simply cannot run. This is the sole reason for keeping an eye on your cash flow statement, a simple document which can reveal lots of information. Here are a few reasons why it is important to carefully analyse it –
- It tells you where money is going
Profit and loss statements don’t tell you where your money is going, they simply give you figures. It is your cash flow statement which paints a picture of where money is coming from and where or to whom you are paying it.
- It helps you make better business decisions
Buying equipment, scaling-up operations and adding extra inventory all use up cash. Sometimes you’ll borrow money, sometimes you’ll use your profits, sometimes you’ll raise capital by other means. Having a cash flow statement helps you visualise all this simply and helps you understand your company’s finances and make better business decisions.
- It’s a good performance indicator
Developing extra cash is a great way to boost performance and a cash flow statement can tell you everything you need to know to do this. Therefore, it is a great performance indicator when used, maintained and analysed properly.
Your cash flow is one of the most important aspects of your business and you should have a comprehensive cash flow statement. As a new start-up, doing this on a month-by-month or quarterly basis is a good idea as it can show you where to invest for growth.