Essay: Understanding Your Startup's Cash Flows

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  • Subject area(s): Business essays
  • Reading time: 3 minutes
  • Price: Free download
  • Published on: August 22, 2017
  • File format: Text
  • Number of pages: 2
  • Understanding Your Startup's Cash Flows
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Why is cash flow management important?

Managing money isn’t what draws people to becoming entrepreneurs, but it’s part of the game. A lack of knowledge about managing cash flows is one of the top reasons why startups fail. A growing company requires more money than a company with a solid footing, so understanding your cash flows is key to sustaining your business. Having a basic cash flow forecast will help you see where you should be spending your money and where potential investments lie.

Cash flow management simply means understanding and keeping track of every inflow and outflow of money. You always want more money coming in than going out, and for startups especially, this is easier said than done. To help maintain positive cash flow, keep a cash flow statement to monitor the change in cash you have on hand.

Why should you keep a cash flow statement?

First, you should know the difference between the cash you have readily available and the amount of money you’re owed, also known as your accounts receivable. When your accounts receivable has a high balance, this is money people have not paid you, and therefore you can’t spend it! Making a profit on paper and having the cash right in front of you are very different, so you always want to encourage people to pay you back as fast as possible. By keeping track of the cash you have on hand, maintaining a positive cash flow will be easier and you can better plan for future expenses.

How do you calculate your cash flows?

Calculating cash flow is pretty simple and consists of three central components: Operating Activities, Investing Activities, and Financing Activities.

Operating Activities

Operating activities are the core activities of your business. These activities are directly related to the product or service you sell. Cash received from the sale of goods or services, receivables from customers, cash interest, and dividends are all considered incoming cash from operations. Outgoing cash includes any payments you make, employee salaries, taxes, and all other expenses related to your core activities. The difference between the incoming and outgoing cash from operations gives you your operations cash flow.

Financing Activities

This refers to money spent and received from external activities that allow you to raise capital and pay investors. Positive cash flow includes incurring debt, selling stock, and any other cash received as debt or equity. This is confusing because debt is normally viewed as a negative, but when you incur debt, such as taking out a loan, the money is considered an asset to you. Repaying your debts, paying dividends, and repurchasing stock are considered to be negative cash flows. The difference between the two flows represents the cash flow from financing activities.

Investing Activities

Investment activities involve the purchase of assets that will create future value. These assets are known as investments. Changes in cash due to plant, property, and equipment (PPE), along with changes in capital expenditures are considered investing activities. Purchasing these assets is a negative cash flow and selling, or divesting, in these assets is considered a positive cash flow. Again, the difference between the positive and negative flows gives you the cash flow from investments.

Once you have calculated the cash flow from all three activities you need to calculate your net cash flow for the period you’re looking at. To do so, add up the final figures from each activity and there you have it! This number represents the amount of cash you generated or lost over the period. A negative cash flow isn’t detrimental to your business, and realistically, you will experience them when you’re first starting out. A negative cash flow just means there was decline in your cash balance over that period, not that you’re out of money.

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