Cash Flow 101

By September 1, 2020Uncategorized

Introducing Tandem Innovation Group’s first blog series: Startup Financial Management 101!  In this four part series, we will be providing the basics on managing your startup’s finances.  From breaking down key concepts, to providing tips, and illustrating through examples; this series is the go-to resource for entrepreneurs.  Curated with the expertise of Tandem network professionals, we want to make it simple for you to understand your startup’s finances.  

Today we are deep diving into cash flow.  We will be explaining what it is, why it is important, and how you can measure it. 

Cash is like oxygen for a business.  Without cash, your business is likely to fail (even if you have a great idea and sound business model).  Your Profit & Loss statement will show you if your business is profitable, but it does not touch on cash flow management.  Your Cash Flow Forecast will tell you whether you have the cash your business needs to survive, but it doesn’t necessarily mean that your business is profitable if you’ve got lots of cash in the bank.  

Successfully raising money does not always amount to a successful business.  Cash flow management can make or break your business.  A business that does not raise money BUT has good cash flow management can often outperform a business with poor cash flow management (even if they have raised a lot of money!)

Cash flow is cash in minus cash out.  

It comes in and out from three sources:

  1. Operations
  2. Financing
  3. Investing

Operations are the sources (i.e. the sale of your products or services) and uses of cash flow from regular business activities.  A profitable business will generate positive cash flow from operations in the long run, but not always in the short run.  It is not uncommon for startups to generate negative operations cash flow early on.  At this stage, operations are geared towards proving a concept, scaling the business, and demonstrating product/market fit and growth potential.  VCs are not deterred by early stage negative cash flow, however, there comes a point when positive cash flows must be generated to sustain the business.  

Financing is the cash flow from debt, equity and grant funding. Money can come from equity investors (friends and family, angel investors, VC funds), or debt (private, venture, banks, institutional investors) or grants (Federal, Provincial/State, or others).  Equity financiers are paid dividends, debt financiers are paid interest and principal, and grants will have certain eligibility requirements that must be met and often reported on.  Debt and grants and are non-dilutive sources of funding.  

Investing is the purchase or sale of assets or acquisitions/disposals of companies or business lines (i.e. acquiring securities of other entities to gain a return).  Technology companies may require significantly less investment than traditional manufacturing or brick and mortar companies.   

There are three main reasons why cash management is important for your startup and they all relate to the timing of when money comes in and when money goes out, which are rarely synchronous. 

 

1. You need cash to cover operating expenses

If you can’t do this, your business can’t survive.  Initial financing rounds fund operations while you develop your business, but later rounds are focused on growth and expansion.  You cannot grow if your existing operations are not self-sustaining.  

 

2. Reinvesting into your business

If you can’t do this, your business can’t grow.  Organic growth (aka bootstrapping) is when a company grows itself using the money it generates.  Organic growth does not rely on raising money, it simply uses profits from operating activities.  

 

3. Returning money to investors

If you can’t show that your business will grow to a point where you will return your investor’s money with a rate of return better than if they put into a safe investment instrument, then your business may not be lucrative enough to raise money through equity.  

There are three key metrics to help you manage your startup’s cash flow:

 

1. Cash on Hand 

Cash on hand is how much money is in your bank account.  You must also be mindful of obligations.  For example, if you have $100k in your bank account, but $100k in payables due next month, you will not have cash leftover afterwards.  

 

2. Burn Rate

Burn rate is how much net cash you are using monthly.  This can fluctuate month to month.  If your business is growing consistently, using the previous month’s burn rate will provide insights on cash requirements going forward.  If cash flow is irregular, an average of the previous months would be a better predictor of cash requirements.  If you anticipate any new costs, it is important to acknowledge them in your burn rate.  

 

3. Runway 

Runway determines how long you have before you run out of cash, given a set of circumstances/factors.  This is simply a rule of thumb, more detailed financial modeling will paint a clearer picture of how long your cash will last.  A good rule of thumb is to always have at least 3-6 months of your burn rate of cash on hand, so you have time to find financing options. 

There are three key cash management tools you can use to stay on top of your cash flow:

 

1. Monthly bank reconciliations

Every month, you should reconcile the transactions in your bank account so they match your records.  This is a good time to check on employee spending and expenses.  Accounting software such as Quickbooks Online or Xero amongst others.., but we like these the most as this allows your team to streamline this process and both softwares link directly to your bank account. 

 

2. Negotiating favourable payment terms 

Ideally, you want your customers to pay you as soon as possible, and you want to pay suppliers as late as possible.  Make payment terms clear upfront, and negotiate them in your favour. 

 

3. Monitor collections

Review your accounts receivable regularly and follow up often.  Good payment terms won’t service you if you don’t collect.  

 

4. Have a live Cashflow Forecasting Spreadsheet 

Review this live document on a weekly or monthly basis, depending on how tight your cashflow is, with updated information from your accounting system so you can adjust your assumptions based on actual ins and outs that happen.   

Stay Tuned!

This is just the start of our financial management series!  Our goal at Tandem is to make it easy for you to establish a sound financial platform to build your business on.  Next, we will be looking at financial modeling; what it is, why it is important, and how you can execute it.

 

Having trouble with your cashflow management?  Looking for more customized support for your business?  If this sounds like you, check us out at tandemig.com to learn more about how we can support your startup.  We offer a network of CFOs, CPAs, and bookkeepers who are ready to take a co-founder approach in managing your startup’s finances and raising capital.   

Our Contributors

Jacinthe Koddo – Contract CFO/COO, Tandem Co-Founder & Director of Client Experience

Tania LoContract CFO/COO, Tandem Co-Founder & Managing Director

Matthew Stevens – Contract CFO

Teresa Pang – Contract CFO

Resources

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