Understanding and Analyzing Company Cash Flow

Understanding cash flow dynamics and how to calculate it can do wonders for your business. Cash flow analysis lays the foundation for ensuring your startup's long-term growth and stability. It provides vital resources for a firm to function effectively. 

But the burning question is, “Are startups aware of effectively managing their cash flows?”

According to a CPA Australian survey, India struggled to manage its cash flows in 2023, with 68% of SMEs resorting to external funds. But, thanks to technological advancements, startups and MSMEs are gradually picking up the pace and prioritizing optimal cost management. 

As per a recent report by the Economic Times, 29% of SMEs are leveraging accounting software and seeking guidance from professional accountants. 

This highlights the importance of cash flow management in helping businesses grow and achieve stability. 

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What is Cash Flow?

Cash flow is the net balance of cash and cash equivalents moving in and out of a business. Startups use cash flow analysis to assess their firms' liquidity. Cash flows represent the cash coming in and going out of the industry and can be positive or negative. No business can ignore cash flow, as it forms the backbone of a company’s operations. 

A positive cash flow ensures: 

• Higher valuation of a startup
• Lower cash burn rate
• Sufficient liquidity to meet immediate needs
• Smooth business operations

Moreover, a startup with a cash surplus enhances its ability to attract investors and secure financing. Let’s understand what cash inflows and outflows entail! 

Cash inflows generally include sales revenue, investment income, and loan financing, while cash outflows consist of operating expenses, debt repayments, and interest. Startups must prioritize measuring cash to obtain clarity over a business’s financial health, which is why this cash flow analysis has become indispensable. 

Cash Flow Analysis

Cash flow analysis tools like a cash flow statement (CFS) clearly show a company’s financial position. The three main components of cash flow analysis include CFO (cash flow from operations), CFF(cash flow from financing), and CFI (cash flow from investing). This analysis helps startups uncover potential issues earlier. Entrepreneurs and investors use metrics like CFS, cash flow conversion ratio, and free cash flow to track a company’s financial success and longevity. 

Apart from providing tools like CFS, a cash flow analysis calculates cash flow to provide additional information. 

Recur Insight: To analyze cash flows deeply, consider using a Chord diagram, which represents the relationships and flows between different financial activities. Another helpful insight is to use Google Sheets to analyze cash flows. Here’s how you can do it. 

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Types of Cash Flow

Cash flows are categorized into three types: 

Operating Cash Flow

Operating Cash Flow (OCF) is the cash flow generated from a company’s core business activities. It includes:

• Revenue from the sale of goods and services.
• Cash outflow due to operating expenses such as rent, utilities, etc.

OCF indicates a startup’s ability to sustain its business operations without relying to external financing alternatives. For instance, if a startup generates Rs. 100,000 from sales and incurs Rs. 56000 in operating expenses, then its OCF would amount to Rs. 44000. Ideally, OCF must be positive as it reflects a company’s capacity to make enough cash to balance its expenses. 

Investing Cash Flow 

Investing cash flow arises from purchasing and selling long-term assets such as property, equipment, and machinery. It represents loans, gains from an investment fund, and a startup’s future investment strategies that may or may not withstand financially volatile markets. 

Example: Hypothetically, a startup invests Rs. 10 Lakhs in machinery for development. To balance the cash outflow, it sells obsolete equipment worth Rs. 5 Lakhs, leaving a negative balance of Rs. 5 Lakhs. This is normal, especially for growing startups who must venture into the financing market to stay afloat. 

In such scenarios, platforms like Recur Club can prove to be game-changers. As India's leading debt platform, we offer swift funding solutions to address urgent financial requirements. We have financed over 700 startups and SMEs and have funded Rs.1000 Crore worth of capital. 

Financing Cash Flow 

Cash flows (Inflows and Outflows) related to debt, equity, and dividends come under Financing Cash Flow. It encompasses financial activities, including principal or interest payments, stock repurchases, dividends issued, and liabilities incurred.  

Imagine a startup raising Rs. 5,00,000 by issuing new shares but paying Rs. 2,00,000 for liabilities incurred. In this case, the FCF will be Rs. 3,00,000, indicating how well the founders can structure their capital and utilize it to meet obligations.

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How is Cash Flow Calculated?

Startups can leverage the contents found in income statements and balance sheets vis-a-vis credit transactions, expenses, and revenue to calculate cash flow between different periods. There are two methods to calculate cash flow:

Direct Method

This method is based on actual cash transactions and includes all necessary expenditures, including payroll expenses, customer receivables, and vendor expenses. Companies use different accounts' ending and beginning cash balances to assess each account's net decreases or increases. This provides a clear picture of cash movements within a company. The formula used in this method is simple.

Cash Flow = Cash Inflows - Cash Outflows

Indirect Method

The indirect method uses accrual accounting and includes non-cash items and changes in working capital. It records revenue and expenses in real time rather than when money is lost or received. It adjusts net income with earnings before interest and taxes (EBIT), operating costs, depreciation, and inventory. 

Recur Insight: An income statement is extremely limited. Hence, startups must prioritize adjustments for earnings before interest and taxes and then other non-cash transactions. Additionally, they should use accounting software to streamline and automate the process to ensure efficiency in recording transactions and assessing the final cash balance. 

Using the indirect method, cash flow can be calculated as: 

Cash Flow = Net income + Depreciation + Decrease in receivables 

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How to Analyze a Cash Flow Statement?

As stated above, cash flow analysis is crucial to determining the answer to a pressing issue: 

”Can your startup generate enough cash to operate and sustain indefinitely?” 

Cash flow analysis requires generating cash statements for 3 major activities, including: 

Operating Activities: 

Cash from operating activities reflects cash received or spent on core business matters such as salaries, rent, and other utilities. A cash inflow from operating activities is considered a green signal for startups as it indicates a stable position to cover expenses and invest in their development. 

Investing Activities: 

Investing activities involve purchasing and selling long-term fixed assets, including property, equipment, capital investments, and other financial instruments. 

Financing Activities: 

Cash flow transactions involving debt and equity and from a startup’s owners or creditors fall under financing activities. Further, it covers cash inflows from issuing or borrowing stocks and cash outflows in repaying loans. 

Why is Cash Flow Analysis Important in Decision Making? 

Cash flow analysis reviews a company’s ability to survive in the long run by assessing its inflows and outflows. When making these statements, companies can observe, plan, and ideate strategies to improve their functioning by adjusting their cash inflows and outflows. This ensures sustainability.

There are 5 steps to analyzing cash flow in the most optimum way: 

1. Identify all sources of income and business expenses
2. Create a cash flow statement
3. Analyze the cash flow statement for operating, investing and financing activities
4. Calculate key metrics like the current ratio, quick ratio and net working capital
5. Regularly review and update the cash flow analysis 

While assessing a company's financial health, two variables come into play: cash flow and profit. They do influence each other, but the two have stark differences. Let’s uncover how they differ! 

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Importance of Cash Flow

“Never take your eyes off the cash flow because it’s the lifeblood of business.”

 —Sir Richard Branson 

Investor, Author and Philanthropist

A healthy cash flow keeps business operations running efficiently. The following points succinctly outline the importance of cash flow. 

1. Liquidity and Operational Efficiency

One of the most important aspects of cash flow is that it measures a firm’s liquidity. Effective cash flow management that focuses on cash inflows optimizes day-to-day operations and identifies areas where cash is used inefficiently, contributing to a startup’s overall performance. 

2. Ability to Meet Short-Term Obligations

Maintaining a healthy cash flow is pertinent to meeting the various short-term obligations of a business, including paying suppliers promptly and fulfilling payroll. By analyzing cash flows from operating activities, startups can run a liquidity assessment, enabling them to determine if they can generate enough cash to meet immediate needs.  

3. Insights Into the Financial Health of the Business

Through cash flow analysis, companies can gain valuable insights to assess the financial health of a business. Not only founders but even stakeholders can evaluate a company’s cash flows, helping them make an informed decision regarding investments, expansion, and the practicality of financial strategies. 

4. Useful During Crisis Management 

By providing insights to business stakeholders about the excess or shortage of funds, cash flow statements can help with crisis management. It helps the finance team take preventive measures to overcome a potential financial crisis. 

5. Analyze Working Capital Requirements

Working capital refers to the funds available to businesses vis-a-vis cash deposits or other reserves to manage day-to-day expenses. CFS can help business executives and investors to track the amount of working capital flowing into the business. This analysis makes it easier for a business to ensure cash inflows. 

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Impact of Positive and Negative Cash Flow

A precise cash flow forecast can solidify your financial position, helping you predict your cash flow situation for a specific duration. And how do startups do that? By assessing the impact of negative and positive cash flow on their business. The following points underline the implications of cash flow variations and their impact. 

1. Positive Cash Flow

Positive cash flow occurs when cash inflows exceed cash outflows. It indicates that your business accumulates cash and your bank balance is growing. This situation offers several advantages:

• Reinvestment: Don’t spend the extra money on sundry expenses! Companies must reinvest surplus cash into the business for valuable purposes like expansion, R&D, or new product launches. For instance, suppose a tech startup, after evaluating its cash flow statement, realizes that it has a positive cash flow even after meeting its obligations. It must choose to invest in developing new software solutions, shifting to a better location, or purchasing equipment.  

• Settling Debts: Positive cash flow can clear all debts, obligations, and liabilities. A by-product of this is reduced interest expenses and improved creditworthiness, which can lead to better financing options in the future.

• Independence From External Financing: Positive cash flow provides businesses with the flexibility to pursue growth opportunities, invest in new projects, or weather economic downturns without relying on external funding. Being independent of external financing reduces the risk of debt or equity dilution, which can dilute ownership and increase financial obligations. Furthermore, without the constraints of external investors, founders and management teams enjoy greater autonomy to experiment, innovate, and pursue long-term growth strategies unencumbered by short-term pressures.

2. Negative Cash Flow

Startups spend cash on expenses like payroll, marketing, and other services. Negative cash flow occurs when cash outflows exceed cash inflows, leading to potential financial challenges:

Expenditure-Income Mismatch: When your startup spends more than it brings in, a negative cash flow is bound to occur. During the initial stages, businesses may deliberately spend on customer outreach to garner sales. A negative cash flow indicates that a company is spending more than it is earning, which can lead to liquidity issues, leading to businesses resorting to financing a loan. 

Expansion Challenges: Switching to a new location or expanding plans can be unsuccessful with negative cash flow. This can hinder a company's ability to invest in growth initiatives. For example, a retail business facing negative cash flow may need more time to open new locations or launch marketing campaigns, limiting its growth potential.

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Examples and Case Studies

Breakdown of Cash Flows in a Business Context

Let's look at an example of how cash flows through a business, using a hypothetical company called Red Bikes:

Red Bikes starts with an initial cash balance of Rs. 75,000. In the first month, they generate additional cash inflows of Rs. 95,000 from various sources:

Accounts Receivable: Rs. 45,000

Loans: Rs. 20,000

Sales: Rs.30,000

However, they also have cash outflows of Rs.25,925 for expenses like rent, payroll, marketing, and taxes.

Subtracting the outflows from the inflows, Red Bikes ends the month with a cash balance of Rs. 144,075. This breakdown illustrates how cash moves through the business and the importance of managing inflows and outflows to maintain a healthy cash position.

Examples of Cash Flow Statements from Real Companies

To understand how startups analyze and calculate cash flows, here is a practical example from Zomato on how their finance team analyzes their cash flows through CFS. 

Zomato

Zomato is a prominent food delivery and restaurant company in India. The image below shows the company’s net cash flows from 2020 to 2024.

The data given above leads to the following observations:  

• Improved Operating Cash Flow: Zomato’s transition from a high-growth phase to a more mature stage is evident in its improved operating cash flow, shifting from negative cash flow in 2020 to positive inflows by 2024. This reflects the company's ability to generate cash from its core business operations.
• Increased Profitability: The progress in profitability over the last four years stems from Zomato’s focus on scaling, improving operational efficiency, and enhancing business durability, positioning the company for long-term financial sustainability.
• Investor Confidence and Capital Raising: The company's successful equity raises in 2021 and 2022 highlight investor confidence in Zomato's growth potential, which has been instrumental in driving its financial stability and growth trajectory.

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The Bottom Line

Simply put, cash flow is a proven method to analyze a company’s financial position. Running a startup without cash flow knowledge is similar to a ship navigating through fog without radar. 

By considering the valuable insights provided by a cash flow statement, a company can evaluate the efficiency of cash management practices, identify trends and patterns in cash inflows and outflows, pinpoint potential cash flow issues or opportunities for improvement, and make informed decisions regarding investments, financing, and growth strategies.

If your startup is consistently recording a negative cash flow balance, don’t worry! It’s normal to spend more than you earn, especially at the initial stages of an entrepreneurial journey.

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Recur Club could help you meet urgent capital needs by securing collateral-free loans from a network of 125+ marquee lenders. From SaaS and manufacturing to D2C and health tech, Recur Club provides tailored financing solutions to startups in multiple sectors. 

If you want to learn more about cash flow strategies, contact our capital experts at Recur Club today! 

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