What is a Cash Flow Statement and Why Is It So Important for A New Company?

Along with an income statement showing that you have a plan to build a large and profitable business, for financing purposes cash flow projections are generally the most crucial aspect of business planing. Investors will almost always look for a cash flow analysis in preference to any other financial statement, because this lays bare the financing needs over time. In larger companies, the cash budget—considering both operating and capital budgets–for a new project or expansion is critical to the overall decision to commit funds and move forward.

Why is cash flow so important? If the cash inflows exceed the cash outflows, the business can continue operations. If the cash outflows exceed the inflows, the business RUNS OUT OF CASH and grinds to a halt. Even if the imbalance is only for a short period, it can spell disaster.  You simply cannot present a plan that shows the business going cash negative.

In its simplest form, cash flow refers to when you will collect and spend money. Think in terms of actual cash, dollar bills, flowing in and out of the business, and then identify both their sources and uses. This is cash-flow analysis.

The main items in a cash flow are:

  • Cash flow from operating activities (this includes all revenue, cash expenses, changes in working capital, cash interest paid, cash taxes paid, etc.)
  • Capital expenditure on equipment
  • Acquisitions of other companies
  • Repayment of debt or equity dividends paid
  • Financing received, whether as debt or equity

If your projections are carefully prepared and convincingly supported, they become one of the most critical yardsticks by which your company’s value is measured by potential investors. Since the merit of your business ultimately depends on what it will accomplish in the future, reasonable estimates of future cash flows will help in arriving at a value. So when your team produces convincing financials it will likewise command a higher value than one that does not.

How much cash a company can generate is one of the more important measures of its health. Yet, you will hear more about P/E (price earnings ratio) than almost any other metric on valuation, but it does not give you an accurate picture of a company’s ability to generate cash.

For a new company, you must produce the most accurate cash flow projections you can if you expect to obtain financing.  What investors really want to see is that you know when and where money will be made, you know what items will affect revenue and cost,  and that the business can grow to the size investors require in order to get the return they want. Creating a model for your business and using it to forecast your financials helps them understand these numbers, and again be confident that you understand them. If you are pre-revenue, the best thing your forecasts should show is how long it will take before you can start generating revenue, how much money you need to get there, and then, how much you’ll need to get again to cash flow positive.  Finally, a sense of scale and margins allows investors to estimate a long-term exit value for their investment.

If you like this information, you’ll really like “Top 10 Mistakes That Cause Investors to Shoot Down Deals”.

About the author: David Brode is the Principal of the Brode Group. An economist by training, Brode has over two decades of experience helping ventures develop and communicate business strategies through financial models so they can launch, grow, and sell businesses.  Brode’s financial forecasting models have been through due diligence dozens of times and have been successful in securing over $11 billion in financing for projects worldwide.  Brode has a B.A. degree in Economics from the University of Michigan.

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