Aidi — Cash flow

Everybody knows that cash is king; the first rule of business is to never run out of cash. Suppose your aim is to build a profitable, long-standing business. In that case, there is a need to understand cash flow management, its impact on early-stage businesses, KPIs to measure and how to manage cash in-between fundraising rounds.

The importance and difficulty of maintaining a suitable cash balance are often times underestimated and taken for granted. Some founders ignore this aspect of the business, sometimes outsourcing this to an external person without regular check-ins until a serious problem comes up. Truth is- if you do not pay attention to cash flow in your business, you’ll be in for a rude surprise. And so, the best way to steer clear of cash-flow-induced problems is to earn a profit (excess revenue over expenditure). 

So what should a founder with little or no financial knowledge know about cash flow? Let’s dig in!

What does cash flow even mean? Harvard Business School defines it as the net balance of cash moving into and out of a business at a specific time. Simply put, it is the sum total of the money brought in and spent over a certain period. The cash flow of a company can be either positive or negative. When more money flows into the business than it moves out, it is considered positive. Likewise, when indications show that more money is moving out of the company than is coming into it, it is considered negative. Many founders rely on regular accounting reports for financial information, especially, their monthly income statement to know the status of cash flow in the business. However, the income statement does not give the full cash flow information founders need.

Cash flow is grouped into 3 components; cash flow from operations, investments and financing activities. Cash flow from operations is the money paid for the acquisition of merchandise, to vendors, to employees (salaries), and other operating expenses. Operational activities provide insights into how much cash a company must make available, or is generated from daily business activities. 

That from investments is described as the process of getting capital to finance a startup or its expansion or any other engagement the startup may need additional funding from either internal or external sources. Financing activity shows if and how much of the operational and investment funds have been gotten from outside or within. This can also entail obtaining cash from stockholders and giving them dividends for their investments in return, borrowing money from creditors and repaying the amount borrowed according to the terms agreed. cash flow from financing activities includes proceeds of cash from issued shares and loan borrowings, and cash payment for financing activities comprises money spent to repay the principal loan amounts, and redemption amount paid for ordinary and preference shares. 

Lastly, cash flow from investment activities shows the amount of money a company made and used in investing in other businesses, buying shares, bonds and securities from other organizations according to viable investment decisions. It also includes the buying of properties and sales of long-held company assets. 

To measure the impact of cash flow on your business, the first thing you need to do is keep records- you cannot measure what you do not know or have sight of. You can keep records either electronically (accounting software, etc) or manually. With this, you have a clear picture of how much money your business owes people - vendors, suppliers, etc, and how much people owe you and cash in the bank/ at hand. Moreso, you need to be sure of your income and expenditure on a monthly and annual basis; successful businesses know their financial status and track it regularly. The cash flow of a business can affect it in the following ways

• Growth/ expansion;

Cash flow can affect the growth of your business either positively or negatively. Positive cash flow gives you more resources to expand the business, employ key staff that will move the company forward and also, affords you the opportunity to purchase needed tools and equipment necessary for business growth. With negative cash flow, you are likely to be struggling with the business; unable to take decisions that will require capital, hence stagnating the company and slowing down expansion. 

• Dividends;

Without cash flow, dividends cannot be paid out to shareholders and investors. When a business experiences cash flow issues and cannot pay dividends as stipulated, this causes friction and a breakdown of the relationship between the founders and investors. 

• Budget;

When there is no positive cash flow, the budget of the enterprise is affected. This may mean that they may not be able to market their product or service and so will be unable to attract new customers or prospects. This may have a negative impact on the company’s revenue potential. Additionally, you may have to cut down on hiring for critical roles. This leaves the business short-staffed, and unable to move forward as the money to hire people who will lead and push the growth efforts and profitability of the company is unavailable. 

Now that we have exhausted the impact of cash flow on a business, we will examine in the next blog post how to manage cashflow, KPIs to measure in this context, how to arbitrate cash flow between operation and corporate needs and finally, managing cash pressure in-between rounds of fundraising.