Cashflow 101 – What You Need to Know

by Tomasz Popiel

6 min read

What is cashflow? How do you manage, visualize and report on cashflow and why does it matter to the success of your startup? This month’s startup finance breakdown is on cashflow. Know to grow.

The information in this article is for educational and information purposes only and should not be relied upon for decision making. Always seek the expertise of a professional advisor or accountant prior to making any decisions.

They say cash is king, and when startups often have limited ability to borrow heavily or desire to take more owner money, nothing rings more true. So how should your startup make sure it doesn’t run out of cash? Here are some tips.

Don’t Use Your Bank Balance as Your Benchmark
While at the end of the day, if your bank balance is greater than zero, you’re still in business. However, that single number doesn’t tell the whole picture of where your business is going. For example, your bank balance won’t tell you about cheques you’ve written but haven’t been cashed. More importantly, a bank balance won’t tell you how much your business is owed and when you can expect these funds, nor will it tell you how much your business owes others and when these amounts are due. Managing cash flow doesn’t just mean managing the money in your bank account today, but also managing the series of transactions that will occur in the future in a way that ensures you won’t fall below zero.

So how do you do this?

Set Up a Way to Track Transactions for Your Business
Whether you use a pen and paper, a spreadsheet, or an accounting package such as Intuit Quickbooks, you need a way to track, monitor, and report on your transactions and the cash in your business. Which method will work best for you? Pick one that you know you are going to use, that is reliable, and is something you can understand. Here’s a quick breakdown of the pros and cons of each:

• While using pen and paper is the easiest and quickest means to start, it is error prone and cumbersome when it comes to monitoring and reporting. Cost: $0.
• Using a spreadsheet is the next easiest step, as it’s an easy and versatile way to get started if you’ve got spreadsheet basics under your belt. Similar to the pen and paper method, it can also be error prone and time consuming to continually have to create reports that are timely and useful. Cost: $0 for solutions such as Google Docs, or the price of Excel.
• The third option is using an accounting software such as Intuit Quickbooks to track, monitor and report on your business. This often takes the longest to set up and can have a learning curve, but it’s rarely as bad as you think. The benefit is that you’ve got one integrated package and reporting is a breeze once you learn to use it.

Ultimately, your preferred choice of tracking cash and cash flow should provide you with information on a few critical things:

Your bank balance plus any outstanding cheques/transactions
When you write a cheque, you’ve made a commitment to pay that amount but it hasn’t yet been reflected in your bank account. Some vendors are awfully slow at cashing cheques so you need a way to know what your cash balance is and how that is different from your bank balance so that you can make important financial decisions.

How much you are owed
Also known as Accounts Receivable or A/R, this is how much customers owe you. You also want to be able to produce an Accounts Receivable aging schedule to catch and follow up with overdue customers and to get an idea about when you might receive the cash. Many customers only pay after 30 days for example. Tracking your A/R and aging schedule gives some predictability to how much cash you will have in the future.

How much you owe
Also known as Accounts Payable or A/P, this is how much you owe vendors, the CRA, employees and so forth. If your business is profitable, also keep an eye out for a tax liability which a professional can help you estimate. Similar to A/R, an Accounts Payable schedule can help you determine when your future cash outflows will be occurring. Knowing this will help you ensure you don’t run out of cash with bills outstanding.

Putting it together
You can calculate your free cash by starting with your bank balance, subtracting outstanding cheques/payments and then subtracting how much you owe (also known as current liabilities).

Free Cash = Bank Balance – Outstanding Payments – Current Liabilities

This tells you how much unencumbered cash you have available right now so that you can make decisions as to how much you can spend at the moment without risk of running out. To add a planning component, you can look at your A/R aging schedule and A/P schedule and forecast how much cash you’ll have in the future when your A/R is collected and your A/P is paid. Be careful though, not all customers pay on time and some don’t pay at all so you may want to leave a cushion when making decisions.

Down the road, you can get even more sophisticated in your planning, but hopefully by then your business is big enough that you can hire a professional to help.

Track Your Cash Regularly
If cash is tight, make sure you know your cash balance every day by ensuring all transactions are entered into your accounting system daily. Making decisions based on incomplete or inaccurate information exposes your business to the risk of running out of cash.

The Cash Flow Cycle
Understanding how much free cash you have is one important aspect of running your business but you also need to understand the flows of cash in and out of your business and what’s tied up and locked in, often called working capital.

Length of your cash flow cycle
Your cash flow cycle length is essentially the amount of time from the start of production, when you begin the service or purchase materials, to when you sell the service or product and collect your cash. The longer your cash flow cycle, the longer you have money tied up in the business that you can’t use for other purposes.

Cash generated per cycle
Ideally, each cash flow cycle will generate some profit and therefore will generate free cash. The higher your profit margin, the more cash you will generate.

Working Capital
Working capital is the amount of cash tied up in your business. The easiest way to imagine this is inventory you’ve purchased with cash that is sitting unsold on a shelf or in a warehouse. This is cash that cannot be easily extracted from your business until it is sold.

You can manage the length of the cash flow cycle by trying to minimize the amount of time each cycle takes and maximize the amount of cash flow cycles per year. Increasing the amount of cash generated per cycle will help you generate the highest amount of positive cash in each cycle. Finally, minimizing the amount of working capital that your business needs will ensure that your bank account has the highest balance possible. Remember, these examples illustrate the dynamics of the cash flow cycle but a good business manager will know when to invest in working capital in order to generate growth or to fill an unusually profitable order.

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