Cash flow is one of the most important indicators of a business’s financial health. It shows the movement of money into and out of your company and is crucial for making informed financial decisions. In this blog, we’ll break down how to calculate cash flow, why cash burn management matters, and how you can easily track and understand cash flow in your startup or small business.
Understanding Cash Flow
Cash flow refers to the total amount of cash that enters and leaves your business during a specific period. It includes cash receipts (inflows) and payments (outflows). Positive cash flow means that your business is generating more cash than it’s spending, while negative cash flow signals the opposite.
Different Types of Cash Flow
Cash flow is typically broken down into three categories:
Operating Cash Flow (OCF):
This represents the cash generated by your core business operations, including sales revenue, payments to suppliers, and employee salaries. For example, if your business generates £50,000 in sales and incurs £30,000 in operating expenses, your operating cash flow would be £20,000.
Investing Cash Flow (ICF):
This shows the cash spent on or received from investments in assets like property, equipment, or securities. For example, if you purchase a new piece of equipment for £10,000, that would be recorded as an outflow in the investing cash flow.
Financing Cash Flow (FCF):
This includes cash movements related to funding your business, such as issuing shares, taking out loans, or paying dividends. If your company raises £100,000 through equity financing but repays £20,000 of debt, your net financing cash flow would be £80,000.
What is Cash Burn?
Cash burn refers to the rate at which your business uses its cash reserves to cover operating expenses before it starts generating a positive cash flow. This concept is especially important for startups that may not yet be profitable. Understanding your cash burn rate allows you to determine how long you can sustain operations before needing additional funding.
A high cash burn rate can indicate inefficiencies or unsustainable spending, while a manageable rate suggests a more balanced approach to growth.
Example of Cash Burn
Let’s consider a hypothetical startup, “TechNova,” a software company in its growth phase. Here’s a breakdown of TechNova’s monthly cash burn:
- Revenue: £50,000
- Operating Expenses:
- Salaries: £30,000
- Rent and Utilities: £5,000
- Marketing: £10,000
- Software and Tools: £2,000
- Miscellaneous: £3,000
- Total Operating Expenses: £50,000
In this example, TechNova’s revenue exactly matches its operating expenses, leading to a net cash flow of £0. However, if TechNova increases its investment in marketing and product development, their expenses rise while revenue stays the same, resulting in negative cash flow.
- Increased Marketing Expenses: £15,000
- New Product Development Costs: £5,000
- Total Operating Expenses: £60,000
- Negative Cash Flow: £10,000
This means TechNova’s cash burn rate is £10,000 per month. If they have £100,000 in reserves, they can continue for 10 months before needing additional funds or cutting costs.
How to Calculate Cash Flow
To calculate cash flow, you’ll need to create a cash flow statement, which gives you a detailed overview of your cash inflows and outflows across operating, investing, and financing activities. Here’s a simple guide to help you calculate it:
- Calculate Operating Cash Flow (OCF):
Start with your net income, then add back non-cash expenses like depreciation and amortization. Adjust for changes in working capital such as accounts receivable, accounts payable, and inventory. - Calculate Investing Cash Flow (ICF):
Add up cash spent on assets and subtract cash received from selling investments or assets. This could include buying equipment or selling securities. - Calculate Financing Cash Flow (FCF):
Add cash received from issuing stock or loans, and subtract cash used to repay debts or pay dividends. - Combine the Cash Flows:
Add up the net amounts from operating, investing, and financing activities to get your total cash flow. - Adjust for Opening Cash Balance:
Add the opening cash balance (the cash at the beginning of the period) to your total cash flow to determine your ending cash balance.
Example of a Cash Flow Statement
Here’s a simplified example of a cash flow statement:
- Operating Cash Flow:
- Revenue: £50,000
- Operating Expenses: £30,000
- Net OCF: £20,000
- Investing Cash Flow:
- Purchase of Equipment: £-10,000
- Net ICF: £-10,000
- Financing Cash Flow:
- Equity Financing: £100,000
- Debt Repayment: £-20,000
- Net FCF: £80,000
- Total Cash Flow: £90,000
- Opening Cash Balance: £10,000
- Ending Cash Balance: £100,000
Conclusion
Understanding and calculating cash flow is vital for maintaining the financial health of your business. By regularly reviewing your cash flow statement, you can monitor the movement of money within your business and make informed decisions that support growth and stability. Tracking cash burn is particularly important for startups, as it helps you plan for future funding and ensure your business can continue to operate smoothly. With proper cash flow management, your business can navigate both stable and challenging times more effectively.
