Cash Flow Basics for Start-Ups

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This article covers the basics of cash flow for a business start-up including:

  • Inflow
  • Outflow
  • Cash vs. Profit
  • Cash Flow Statements

If you are reading this it is likely you have started up a business of your own – congratulations! You may also be an entrepreneur looking for more information on cash flow. Regardless, we warn you this information may be dry as bone… However, adequate cash flow is critical to a start-up business and knowing more on this subject is always helpful for any entrepreneur.

During the start-up phase businesses need to purchase products and services to get their new business running, all while sales may not be occurring yet. Learning to manage cash flow during this establishment period is critical to the success of any start-up. While many entrepreneurs may not be comfortable with cash management, it is important to understand how to manage their business’s cash, especially in this critical phase of business. Here are our 4 BIG basics of cash flow for start-ups:

Cash Inflows

Cash inflow is the money coming into a business, also known as the revenue or income. This can consist of sales, investments, or financing. Cash inflow is the opposite of the cash outflow, which is the money leaving the business. A business is considered to have a healthy cash flow when its inflow is greater than its outflow. In accounting this would fall under Accounts Receivable, which is money owed from customers on the goods or services sold by the company. Start-ups may not be at the point of having sales in their business yet, which makes understanding cash flow even more important. In order to pay for the bills and start-up costs in the beginning days of business start-ups have various options. Many start-ups look to a bank line of credit, investors, or their own personal cash and savings to fund the business until it is has sales and is producing income.

Cash Outflows

Cash outflow is the money leaving a business, also known as the expenses. This can include business purchases, rent, payroll, training, insurance, and taxes. Business purchases will vary depending on the type of business. It is important to forecast your future expenses so that you know how much cash is required each month to cover your costs. If a company consistently has lower cash inflow than outflow, it may eventually become bankrupt. In accounting this would fall under Accounts Payable, which is money owed by you to the suppliers on the goods or services you purchased.

Selling services requires less up-front costs vs. item sales, as there is no need to maintain an inventory of items to sell. Businesses selling products will need to either stock the product itself or the components to create the product. Most businesses need computer equipment, office supplies and office furniture such as desks and chairs, which would all require purchases that would be considered part of the cash outflows.

Cash vs. Profit

Think of cash flow as a picture of your bank account. More money coming in than going out is positive cash flow while more money going out than coming in is negative cash flow and leads to an overdrawn account that shows in the negative. Your businesses cash flow consists of inflows and outflows as described in the 2 sections above.

Profit on the other hand is an accounting term for when you have a positive cash flow, meaning your business’s cash inflow (revenue) is greater than the cash outflow (expenses). The formula in accounting for profit is revenue minus expenses [Profit = Revenue – Expenses]. Even though a business may have sales, if the customers are not paying in a timely fashion there will be accounts receivable outstanding but no cash in the business, meaning no revenue yet. In other words, Accounts Receivable transactions will not be considered as revenue until your business receives the actual cash payment. One of the biggest threats a company can face is having assets and accounts receivable, but no cash in the bank to pay the bills. This is unfortunately one of the number one reasons that many small businesses face bankruptcy and are forced to close before finding success.

Cash Flow Statement

A formal accounting Cash Flow Statement (CFS) has three main components:

  • Operating Activities
    These are the activities that are required to sell your products or services in order to generate revenue. This could include transactions such as sales, accounts receivable and accounts payable. These are essentially the cash movements to support the business continuing to operate.
  • Investing Activities
    These transactions usually consist of the purchasing and sale of long-term assets. This can include physical assets such as computers, equipment, and land, or non-physical assets such as investments in securities stocks and bonds.
  • Financing Activities
    Financing activities are most often associated with the borrowing and repayment of bank loans. They can also include issuing or reacquiring shares in the business and paying cash dividends on capital stock.

These include transactions involving debt, equity, and dividends.

      • Debt would include any outstanding loans or expenses.
      • Equity is any owned assets that may have debts or other liabilities attached to them, this is calculated by subtracting the liabilities from the value of the assets [Equity = Value of Assets – Liabilities].
      • Dividends are the distribution of the company’s profits to its shareholders.

A small business owner can do a simplified version of a cash flow statement by listing cash inflows minus cash outflows, which would give the net cash flow [Net Cash Flow = Cash Inflows – Cash Outflows]. If the result is a positive number, then there is positive cash flow and if number is negative, then there is negative cash flow. If a company has negative cash flow, they may have to dip into reserves or make use of their financing options; this is why it is so important to have a clear understanding of your cashflow status at all times.

Go with the Flow!

Understanding your cash flow is very important in a start-up company. The company may not be in a position to generate cash yet, so it becomes essential to prepare and budget for the future. By taking a proactive approach and tracking cash inflows and outflows, business owners can help manage their cash flow and plan for contingencies so they can focus on growing their small business into a BIG success!

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