Cash Flow

This week on MBA Mondays we are going to talk about cash flow. A few weeks ago, in my post on Accounting, I said there were three major accounting statements. We’ve talked about the Income Statement and the Balance Sheet. The third is the Cash Flow Statement.

I’ve never been that interested in the Cash Flow Statement per se. The standard form of a cash flow statement is a bit hard to comprehend in my opinion and I don’t think it does a very good job of describing the various aspects of cash flow in a business.

That said, let’s start with the concept of cash flow and we’ll come back to the accounting treatment.

Cash flow is the amount of cash your business either produces or consumes in a given period, typically a month, quarter, or year. You might think that is the same as the profit of the business, but that is not correct for a bunch of reasons.

The profit of a business is the difference between revenues and expenses. If revenues are greater than expenses, your business is producing a profit. If expenses are greater than revenues, your business is producing a loss.

But there are many examples of profitable businesses that consume cash. And there are also examples of unprofitable businesses that produce cash, at least for a period of time.

Here’s why.

As I explained in the Income Statement post, revenues are recognized as they are earned, not necessarily when they are collected. And expenses are recognized as they are incurred, not necessarily when they are paid for. Also, some things you might think of as expenses of a business, like buying servers, are actually posted to the Balance Sheet as property of the business and then depreciated (ie expensed) over time.

So if you have a business with significant hardware requirements, like a hosting business for example, you might be generating a profit on paper but the cash outlays you are making to buy servers may mean your business is cash flow negative.

Another example in the opposite direction would be a software as a service business where your company gets paid a year in advance for your software subscription revenues. You collect the revenue upfront but recognize it over the course of the year. So in the month you collect the revenue from a big customer, you might be cash flow positive, but your Income Statement would show the business operating at a loss.

Cash flow is really easy to calculate. It’s the difference between your cash balance at the start of whatever period you are measuring and the end of that period. Let’s say you start the year with $1mm in cash and end the year with $2mm in cash. Your cash flow for the year is positive by $1mm. If you start the year with $1mm in cash and end the year with no cash, your cash flow for the year is negative by $1mm.

But as you might imagine the accounting version of the cash flow statement is not that simple. Instead of getting into the standard form, which as I said I don’t really like, let’s talk about a simpler form that gets you to mostly the same place.

Let’s say you want to do a cash flow statement for the past year. You start with your Net Income number from your Income Statement for the year. Let’s say that number is $1mm of positive net income.

Then you look at your Balance Sheet from the prior year and the current year. Look at the Current Assets (less cash) at the start of the year and the Current Assets (less cash) at the end of the year. If they have gone up, let’s say by $500,000, then you subtract that number from your Net Income. The reason you subtract the number is your business used some of your cash to increase its current assets. One typical reason for that is your Accounts Receivable went up because your customers are taking longer to pay you.

Then look at your Non-Current Assets at the start of the year and the end of the year. If they have gone up, let’s say by $500k, then you also subtract that number from your Net Income. The reason is your business used some of your cash to increase its Non-Current Assets, most likely Property, Plant, and Equipment (like servers).

At this point, halfway through this simplified cash flow statement, your business that had a Net Income of $1mm produced no cash because $500k of it went to current assets and $500k of it went to non-current assets.

Liabilities work the other way. If they go up, you add the number to Net Income. Let’s start with Current Liabilities such as Accounts Payable (money you owe your suppliers, etc). If that number goes up by $250k over the course of the year, you are effectively using your suppliers to finance your business. Another reason current liabilities could go up is Deferred Revenue went up. That would mean you are effectively using your customers to finance your business (like that software as a service example earlier on in this post).

Then look at Long Term Liabilities. Let’s say they went up by $500k because you borrowed $500k from the bank to purchase the servers that caused your Non-Current Assets to go up by $500k. So add that $500k to Net Income as well.

Now, the simplified cash flow statement is showing $750k of positive cash flow. But we have one more section of the Balance Sheet to deal with, Stockholders Equity. For Stockholders Equity, you need to back out the current year’s net income because we started with that. Once you do that, the main reason Stockholders Equity would go up would be an equity raise. Let’s say you raised $1mm of venture capital during the year and so Stockholder’s Equity went up by $1mm. You’d add that $1mm to Net Income as well.

So, that’s basically it. You start with $1mm of Net Income, subtract $500k of increased current assets, subtract $500k of increased non-current assets, add $250k of increased current liabilities, add $500k of increased long-term liabilities, and add $1mm of increased stockholders equity, and you get positive cash flow of $1.75mm.

Of course, you’ll want to check this against the cash balance at the start of the year and the end of the year to make sure that in fact cash did go up by $1.75mm. If it didn’t, then you have to go back and check your math.

So why would anyone want to do the cash flow statement the long way if you can simply compare cash at the start of the year and the end of the year? The answer is that doing a full-blown cash flow statement tells you a lot about where you are consuming or producing cash. And you can use that information to do something about it.

Let’s say that your cash flow is weak because your accounts receivable are way too high. You can hire a dedicated collections person. You can start cutting off customers who are paying you too late. Or you can do a combination of both. Bringing down accounts receivable is a great way to improve a business’ cash flow.

Let’s say you are spending a boatload on hardware to ramp up your web service’s capacity. And it is bringing your cash flow down. If you are profitable or have good financial backers, you can go to a bank and borrow against those servers. You can match non-current assets to long-term liabilities so that together they don’t impact the cash flow of your business.

Let’s say your current liabilities went down over the past year by $500k. That’s a $500k reduction in your cash flow. Maybe you are paying your bills much more quickly than you did when you started the business and had no cash. You might instruct your accounting team to slow down bill payment a bit and bring it back in line with prior practices. That could help produce better cash flow.

These are but a few examples of the kinds of things you can learn by doing a cash flow statement. It’s simply not enough to look at the Income Statement and the Balance Sheet. You need to understand the third piece of the puzzle to see the business in its entirety.

One last point and I am done with this week’s post. When you are doing projections for future years, I encourage management teams to project the income statement first, then the cash flow statement, and then end up with the balance sheet. You can make assumptions about how the line items in the Income Statement will cause the various Balance Sheet items to change (like Accounts Receivable should be equal to the past three months of revenue) and then lay all that out as a cash flow statement and then take the changes in the various items in the cash flow statement to build the Balance Sheet. I like to do that in monthly form. We’ll talk more about projections next week because I think this is a very important subject for startups and entrepreneurial management teams to wrap their heads around.

#MBA Mondays

Comments (Archived):

  1. frankwoodmanjr

    Very good general discussion of Cash Flow. It is a concept that is hard for many business people to understand but it is so important to have for proper budgeting and planing. Much like depreciation expense Cash Flow is a concept that isn’t intuitive to understand.Keep up the great articles.

  2. Erol

    Very well explained (perhaps the best MBA mondays post yet.) The last paragraph mentions creating projections. I wonder if a discussion on unit economics and how to test business viability is in the pipeline. I’d be very interested in seeing your approach to deconstructing these statements when an entrepreneur gives you a business plan.Thanks!

    1. Tereza

      Agree. Would like to hear Fred’s take on it.Especially re: all those Freemium businesses. Icky looking cash flows until you get enough users and figure out the “-mium” part!

      1. fredwilson

        here’s a great post on some freemium case studies…

        1. Tereza

          This is awesome!!!!Thx!

    2. fredwilson

      i will take that suggestion and put it on my list, which is growing by theweek

  3. Dan Ramsden

    I really look forward to next week’s projections topic, as this may lead to a discussion of “terminal value,” which is in many ways the crux of the whole matter.

  4. paramendra

    “Show me the money!” (Jerry McGuire)The phrase Cash Flow curiously sounds like the phrase The Stream. I see an app in that.

  5. eroltoker

    @Dan (sorry, posted incorrectly) It would be interesting to hear Fred’s insights on Terminal Value. I generally go with year 5 profit and a discount rate similar to the annualized GDP growth rate over a decade to be conservative, since this is often the most arbitrary part of the valuation model (if you get criticized for forecasting 5 years out, how can you possibly forecast infinite growth after that?)

    1. eroltoker

      It would be interesting to hear Fred’s insights on Terminal Value. I generally go with a measure similar to an annualized GDP growth rate over a decade to be conservative, since this is often the most arbitrary part of the valuation model (if you get criticized for forecasting 5 years out, how can you possibly forecast infinite growth after that?)

  6. awaldstein

    Fred, thnx for this. A great refresher course to start the week.

  7. zackmansfield

    For a start-up still in “burn phase”, I’d argue that understanding cash flows is the most important of the financial statements. Having a realistic understanding of remaining months of burn, and the implications of different sensitivies to sales/hiring/capEx etc on liquidity in the company is of extreme importance because is impacts timing/valuation of next round. And inefficiency in understanding can have management running around trying to raise money desperately, which has a profound negative impact on the operations of the co (and therefore exacerbates any cash flow problems). Can be an ugly, self propagating problem if not handled correctly. I encourage entrepreneurs, who are by nature very optimistic, to be very cautious and realistic when thinking through cash flows of their company. Yet another case where you’re better safe than sorry.

    1. fredwilson

      Yup. So true

  8. Simon Monger

    While investing in public companies, the cash flow statement is particularly useful.Companies can inflate the income statement in a number of ways that can be uncovered in the statement of cash flows. For example, changing income recognition accounting practices or overstating inventories (leading to a lower cost of goods sold) can manipulate net income. However, checking this against operating cash flows can quickly uncover what is happening.On the flip side, net income can also be negatively impacted by warrant liabilities, for those (in my opinion) ill-advised smaller companies that take on ridiculous warrant financing. The fair value of the warrants are often written off each period in the income statement, since they could be exercised, and that would lead to an expense. Again, looking at operating cash flows can show you the real picture here (along with an adjusted EBITDA number that companies usually provide, but that can be misleading as well, if it avoids other costs that should be added in).

    1. fredwilson

      Cash doesn’t lie 🙂

  9. jeremystein

    >>But as you might imagine the accounting version of the cash flow statement is not that simple. >>Instead of getting into the standard form, which as I said I don’t really like, let’s talk about a >>simpler form that gets you to mostly the same place.for clarity there are two ways to derive the cash flow statement. the method you described is called the indirect method.

    1. ShanaC

      So what is the direct method?

      1. jeremystein

        under the direct method you convert the line items of the income statement to cash receipts or payments. under the indirect method you start with net income and then make adjustments that are non cash transactions. direct represents the operating receipts and payments whereas the indirect only shows the result of the transactions (the differences between NI and OCF)

        1. fredwilson

          Thanks for that explanation jeremy

      2. jeremystein

        under the direct method you convert the line items of the income statementto cash receipts or payments. under the indirect method you start with netincome and then make adjustments that are non cash transactions. directrepresents the operating receipts and payments whereas the indirect onlyshows the result of the transactions (the differences between NI and OCF)

    2. fredwilson

      What’s the other one called jeremy? You are clearly up on this stuff

      1. jeremystein

        the direct method.

  10. Ben

    Now that you have covered all 3 financial statements, which one is most likely to be “manipulated” (And I don’t mean just fraudulent). Which one gives you the “warning” signs first?

    1. Tereza

      That’s a really good question! Very eager to hear from the Oracle on that.Took a good course in b-school called ‘advanced accounting’ which in fact was a survey all the kooky places corporations manipulate the statements, a different focus each week! Included some crazy showcased stories from real live auditors. Not sure how/why, but I did better in it than the intro accounting course.I think Kid could have a field day on this one for his Monday Night Kookonomics lecture.But in all seriousness, will really appreciate hearing the VC/start-up angle….

      1. ShanaC

        That sounds like an amazing class. I took a business history class- it looks like any of these could be manipulated, it depends what is in vogue.

    2. jeremystein

      they are all related so it really depends on management motivation.different depreciation methods will affect the balance sheet, income statement, etc. so you need to understand if management is looking to boost earnings, maintain certain coverage ratios and so forth.

    3. PhilipSugar

      Generally speaking non-cash changes to the balance sheet that are out of whack with the growth of the business are the first warning sign…..assuming fraud is not involved…like Lehman moving liabilities off balance sheet.So if the business is growing top line at 10% and receivables go up by 30%….you begin to wonder are sales getting booked on the 32nd or 40th day of the month?Same for assets….is management capitalizing expenses to make the number?Same for liabilities.Any manipulation of the P&L has to show up on the Balance Sheet which flows through and ties back to cash.So if you truly tie to cash…..and on that you can’t fudge without fraud you can see the rest

      1. fredwilson

        This is going to be a whole post soon

    4. fredwilson

      Cash flow is the tellIncome statement is the lie

      1. PhilipSugar

        You know the key is to make them both the tell.When I was young some of the best advice I got from an old sage of a board member was: “Phil you can lie to anybody you want….me, the board, your vc’s, your mother for all I care, but never, ever lie to yourself”I was in a big argument with somebody and they wanted to engineer the numbers….I am very capable of engineering the numbers but I wouldn’t.You know if you start engineering the numbers everybody below you participates and soon you are working towards engineering a number and not building a company.One of my big things is to simplify the numbers as much as possible and report on them quickly. It goes down to everything. All employees are paid on the last day of the month, all expenses are due on the second to last day, all invoices are generated on the first and mid-periods are pro-rated, same for expenses.In this way I already have the first quarter numbers on my desk.I have the second quarter projections as well, because we are a subscription business.I will not however allow the mental masturbation of trying to figure out the third quarter numbers.So my goal is always know where you were, know where you’re going but don’t spend time anywhere else.

  11. Geoff D.

    Cash is King.

    1. Eric Leebow

      Content is King as well.

  12. Tereza

    It’s Monday morning, the height of tax season, pissing rain out outside, we’re hung over from some particularly nasty online chats this weekend, and having a straight, honest talk about Cash Flow.So necessary. And yet so……….depressing.Somebody scrape me off the floor, please?:-)

  13. PhilipSugar

    I have a spreadsheet that I’ve developed over the last fifteen years that ties all three together.I’m willing to open source it.Important to note the one thing you can’t fudge is cash. Everything else accountants can manipulate.

    1. ShanaC

      That would be amazing….

    2. Daniel Chow

      That would be great – please do share. Just out of curiosity, what are the three things your spreadsheet will tie together? I am guessing that you mean the cash flow statement, profit & loss and balance sheet, but was just wondering if you meant otherwise.

      1. PhilipSugar

        I posted the latest (for some reason the balance sheet worksheet wasn’t included)It ties the P&L to CashFlow to the Balance Sheet. It also ties in a hiring forecast and a subscription revenue service with a channel to the P&LThe P&L is called a Proforma because it is a projection.You can see how it all ties out where Assets = Liabilities + Equity on the Balance Sheet. I even included that line to show how it balances.I am going to admit that the Balance Sheet is a bit rudimentary and you’d have lots more items in reality….like capitalizing organization costs, options, acquisitions, etc, etc…..but the reality is that for startups what really counts is Cash Flow first…..then P&L, then the Balance Sheet just really flows.Note how SUPER profitable this startup is but it needs cash because the receivables eat up money. Make it less profitable by adding expenses and watch it chew up cash.

    3. fredwilson

      Right onPost it to a google spreadsheet and make it publicThanks!!!!!!

  14. sbrita

    A great post that explains the important of cash – -as we live in a world of cash, not income statements. Having cash on hand is very important to pay for items but also in order to avoid taking on short (or long) term debt. Would be great if you took the next step and discussed your opinion on operating costs vs. operating budget and how that fits into cash flow. When is it good/bad to take on debt?

  15. Christian Brucculeri

    Great post on an important topic.I’ve traditionally had the most trouble trying to predict cash flows when writing business plans; there are just so many variables. When creating business plans and projected revenues, is it sufficient to simply attach a Net Working Cash Flow Line to your P&L statement, or do you expect a separate cash flow statement?It seems like it would be difficult to predict cash flow movements from the Income statement simply because of how “broad” Income Statements are. I’ve always like P&L statements because I can sort of list every item out.

    1. fredwilson

      Just a cash projection seems enough to me

  16. HowieG

    GREAT POST!Simply put why this is so important, everyone just needs to see how many businesses go under, that have assets, but no cash to fund their operations. And when you see public companies getting shorted in the markets often it has to do with cash flow. Can they meet debt payments. Are they spinning off enough profits to cover operational needs or to help them pay down debt. Circuit City is a great example of a company taken private, loaded up with debt and failed because of lack of cash flow.

    1. Lawrence Sinclair

      For small ventures, cash flow can sometimes be the only thing that matters. Assets, especially in Internet ventures, are totally meaningless, at least as measured by balance sheets. Liabilities are only a problem one needs to worry about if the venture succeeds. But when one run out of cash, it does not matter how rosy next year might have been; everyone packs up and goes home and the venture becomes a regret.

  17. ShanaC

    See this is really interesting- this explains why you would want to take a certain action and when…Next question, since this is dual book accounting, how do you get the worldview of the numbers to line up- as in you have good cash flow but you are underwater, or horrible cash flow but not underwater? It is not something in the accounting, but it is something that will show up in the balance sheet. How can you use the balance sheet as a tool to point to what you should do next?

    1. jeremystein

      what do you mean by underwater? ability to pay off creditors? insolvent? etc?

      1. ShanaC

        I don’t know, it depends on the sheet I am looking at- and that is something I would like to know what I should be looking for when…

        1. jeremystein

          the three statements are closely linked but i will give you some basics:on the balance sheet you would want to look at liquidity (current, quick, …) and solvency ratios (d/e, fin leverage)on the cash flow and income statement you would want to look at FCFF, FCFE, coverage ratios (int cov, reinvestment, debt coverage …), and performance ratios (cash roa, cash/income, cf/rev, …)

          1. jeremystein

            i should be more specific and say that there are inventory ratios, etc. all ratios need to be analyzed in context with the business because each industry is different. it is important to understand how these ratios change over time.

          2. ShanaC

            Thank you so much.

          3. JLM

            Looking at the pertinent financial ratios over time is the best way to plot the progress of a business.Liquidity ratios — current ratio, quick ratio, cash ratioAsset turnover ratios — receivables turnover, average collection period, inventory turnover, inventory periodFinancial leverage ratios — debt to equity, debt coverage, interest coverageProfitability ratios — gross profit, return on assets, return on equitySlowly begin to work through and graph the easy ones over time adding more eclectic ones as you master their calculation and GRAPH them.Let the graphs develop a trend and understand and analyze the trends.This is the canary in the mine shaft. Use it so.

      2. ShanaC

        Excellent question- we didn’t discuss that… we discussed cash flow versusprofit/loss. So technically you can be underwater in one and not the other. Which one makes the most sense to freak out over and when?

        1. jeremystein

          are you referring to the ratios or financial statements?

          1. ShanaC

            I think I would need a deep in depth study to be sure. I think for the level of understanding I have- the statements. Though the ratios sound interesting….

          2. jeremystein

            in that case, you should pay more attention to the cash flow income is an accounting number. the easiest way to understand this is to look at the depreciation and income tax expense.if you choose an accelerated depreciation schedule, earnings at the beginning of an assets useful life will be lower compared to using a straight line schedule. this will reverse in the later years.the income tax expense listed on the income statement can be misleading because it can differ from actual taxes owed. it is not wholly representative of how much cash if flowing in and out of the business because the actual number can differ due to tax loss carryforwards, deferred tax assets and liabilities, etc.paying attention to the cash flow statement will give you a better idea of how the business is performing.

          3. ShanaC

            Thank you so much for answering my questions…you did a really good job.

    2. zackmansfield

      “horrible cash flow but not underwater” = company which has raised a boatload of venture $ and has tons of liquidity (at the moment). But don’t be too comfy, these are the ones which can get really ugly.”good cash flow but you are underwater” = hard to think of an example of this, namely b/c if you have *good* cash flow, you’re money (pun intended). My only caveat would be to re-emphasize what Fred said re: operating cash flow vs. cash drain from investment. It’s possible to have great operating cash flow (i.e. profits from your sales) but if this requires continued massive capital investment (servers or machines or factories, etc), your net cash flow could be bad. I guess there’s a lot depending on what *good* cash flow is defined as…

      1. ShanaC

        And thank you too.

  18. W. Michael Hsu

    Another fantastic post Fred. Your ability to explain the 3 basic financial statements in plain English continues to amaze me. I’d like to point out that the most important part of this post IMO:”The answer is that doing a full-blown cash flow statement tells you a lot about where you are consuming or producing cash. And you can use that information to do something about it…”So many companies that I worked with demand a cash flow statement to be produced but they do nothing with it. Always remember that financial statements are produced to provide information so you can act upon it. Don’t just file it in a pretty binder on your shelf and forget about it. My favorite is: “I’ll just have it in case of an audit.” <– a financial statement is so much more than that.Thanks again for sharing.

  19. hildavis

    As a past equity research analyst and now an entrepreneur, I think the cash flow is important and the complexity of it depends on the size of your business as measured by revenues and vendors. For example, Gap, Cisco, Google, etc have extremely large companies that need an intense line item heavy CF statement. A start-up should not need that detail of reporting.For my current business, which should generate $10M+ in revs this year, I have a very detailed, line item P&L that models every expense line from office supplies to insurance to each employee that lets me know operating profit or loss before cap ex items (uses of capital). This helps me understand the operating cash I need for the business, and also lets me know if I am ahead or behind my op ex cash burn.I then have the monthly Op Ex cash number flow through the sources and uses model. We sell apparel, so we have to buy some products in advance, which creates lumpiness in our cash needs. This gives me a total cash burn for the month for every month, (op ex + sources and uses) and that number is linked to my cash balance, so my cash balance adjusts accordingly.So if I am positive $25,000 on monthly op ex but need to buy product in the same month for $200,000, I am going to burn $175,000 of my cash balance. And if my cash balance was $2,000,000 then I end the month with $1,825,000 in the bank.So the most important items I think for small businesses are (1) a very detailed line item P&L and include an “Other” line item and make it $10,000 to $20,000 in expenses a month because you will have expenses that you never thought of, some one time and some recurring, (2) a detailed sources and uses model that forecasts what you need to buy to grow your business, and (3) a single line item for your beginning and ending cash balance.As your business grows, you will increase the detail of item 2 and 3, but I do not think it is as important for smaller businesses.

    1. fredwilson

      Yes. What you are suggesting is a p&l with a quick bridge to cash. That’s a good way to go for a small business. But you have to understand the cash flow statement to build that bridge

  20. Eric Leebow

    Great post, at the end of the day cash is king (so is content), yet every business should be proud of they way their cash comes in and goes out. If you’re taking in cash, and your customer was not 100% satisfied with the service, then you don’t deserve it, and if you’re spending cash on things that don’t behoove the business, then you’re not spending wisely. Boxee is an interesting example, wonder if that is considered hardware requirement, as you mentioned about servers. It’s funny, as when I met Avner for the first time, he told me that they have no intention to have a hardware box, and I insisted on them making one, and here they are coming out with one. So, now they have a physical box, and it’s making them cash flow negative as a company. They are not pulling a profit from selling these boxes, yet it’s a business requirement because its business cannot exist without such a piece of hardware. It surprises me that they make nothing on selling the box, yet I see this company going public someday, and it will be a huge success. The one thing that’s true about Boxee is that it can take this hardware piece, and it will make them a huge cash flow someday. Average people may not have the Boxee Box in their homes today, yet it has huge potential upside in the years to come. This is one example, where you can say the hardware has created a cashflow negative, yet it has great potential energy. I equate Boxee’s Box to the Nexus One, as they are both Open Sourced, and its equipment will allow for the company to generate future revenues.

    1. fredwilson

      They don’t make the box. Their hardware partners do

  21. Andy

    Fred, I love your MBA Mondays posts. I’m not into finance but the technical position (management) i have at a software company expects managers to understand how a business is run, there is a bias towards marketing and sales so if you don’t have that background then you’re at a slight disadvantage. Your posts are very helpful and I’m recommending them to other managers as well. I don’t know if you realize it or not but this is a real service you’re providing here :-)Thank you, Andy

    1. fredwilson

      I know it and I am enjoying providing it very much

  22. Glenn Gutierrez

    Thanks for the education. This is why I think MBA Mondays rock.

  23. JLM

    The cash flow statement is very easy to derive and understand if you will remember some very, very simple rules. Before you start, get out your income statement and your balance sheet and your cash receipts/disbursements journals and review the results.If you use QuikBooks to handle your accounting all this stuff is automatically available at a push of a button once you have entered everything.Income statement is operating performance over time and balance sheet is a snapshot which can be compared to the same starting period as the income statement thereby signalling changes over the same time period.The cash flow statement is derived from three (3) simple questions or areas of emphasis:1. What were the results of “operations”? Did we generate or consume cash through operations? <<< look at the income statement to answer this question1A. What non-cash costs were included in “operations” which should be backed out? Depreciation? Amortization? Stock based compensation? Gain or sale of a business unit which was included in opertions? Asset impairments and contract termination costs. <<< look at the income statement for non-cash expenses1B. What happened to our asset and liability account balances? Did accounts receivable go up or down? What happened to our trade accounts payable? How about accrued expenses and other current liabilities? <<< look at the balance sheet2. What was the impact of “investing activities”? Did we purchase any property, plant or equipment? Did we purchase any goodwill or intangibles? Did we sell sell any equipment? Did we receive repayment of any promissory notes? <<< look at the balance sheet and your cash disbursements/receipts journal3. What was the impact of “financing activities”? Did we borrow any money? Pay off any debt? Receive any settlements? Sell any common stock? Repurchase any common stock? Receive any proceeds from the exercise of options? <<< look at the balance sheet and cash receipts/disbursements journalIn it simplest form the cash flow statement starts with the cash/cash equivalents at the BEGINNING of the term and then adds/subtracts the results of —OperationsInvesting activitiesFinancing activitiesresulting in the cash/cash equivalents on hand at the END of the period.Remember the convention on the +/- sign will always be — did this item generate (+) or consume (-) cash?Check, double check and re-check the ending cash balance with your bank balances to ensure they match. Whatever your cash flow statement says is the ending cash amount must be somewhere — like in your bank accounts.The first couple times can be a bit confusing but it all makes sense if you ask yourself whether something generated or consumed cash and whether it is truly a cash cost or not!Go through it w/ a CPA a couple of times and it will be perfectly clear.

  24. ea exam

    Very good post! Brings to mind stuff from Rob Kiyosaki’s Cashflow Quadrant. Nicely done.

  25. PhilipSmith

    I agree that the “traditional” presentation is hard for people to wrap their heads around, particularly those less-experienced in reading such financial statements.For early stage (and some later stage) companies I always ensure there is an additional statement available for cash flow that simplifies it further. It focused on the real things you do to bring money in, and the ways it really goes out. It starts with your beginning accounts receivable (what people owe you), adds billings (new sales or invoices) and collections (what came in) lines and ends with ending accounts receivable, along with a few metrics and perhaps customer details. Now you know the cash inflows and can look at things like how long it takes to collect etc.On the spending side, people understand things like Payroll, Benefits, Consulting, Rent, Computer Equipment and other payments a lot better – stuff you write checks for! So I list out these main categories and any unusual items from the period in question.None of this replaces the traditional accounting stuff which, yes, you gotta do and do right – but it supplements it with information that really explains where the money went!

  26. scooter

    Fred, this paragraph: “Cash flow is really easy to calculate. It’s the difference between your cash balance at the start of whatever period you are measuring and the end of that period. Let’s say you start the year with $1mm in cash and end the year with $2mm in cash. Your cash flow for the year is positive by $1mm. If you start the year with $1mm in cash and end the year with no cash, your cash flow for the year is negative by $1mm.”can be misleading. While that is technically your cash flow, you need to subtract out any changes in debt or equity to get a truer picture of cash flow. in your example, if a company starts a period with $1MM in cash and ends with $2MM in cash, but raises $1MM in equity during that period, it is more accurate to say that their cash flow is $0.

  27. Mark Essel

    I fell asleep halfway through.Ok snapped out of the haze and finished the read. I’ve got a fuzzy image of a pile of captial, and that pile is composed of both liquid and nonliquid assets. There are multiple sources in and out of that stack, if the stak dips down I’m in trouble. If the stack curves up, I could be ok as long as the streams in and out don’t result in a negative result if integrated.I can dig the tools used to track the financial health of a business. I have an inkling I can describe the present, past and future financial status of a business with a simpler model. But I’m time bankrupt.

    1. ShanaC

      *snicker* I’m sorry that image is funny…I like reading this stuff once I become attentive.

  28. Daniel Chow

    I have never seen anyone explain the cash flow statement any better – well done Fred, great post.

  29. PhilipSugar

    Last post…..looking at my subscription revenue I didn’t put in a renewal rate.I just did and posted.Look how that ONE (sorry for caps but this deserves it) number changes everything.Move the renewal rate from 75% to 40% and watch the business go unprofitable, the balance sheet go to hell, and the cash flow go negative.…@philipsugar

  30. timtasker

    Great article, thanks for sharing!I think this is so valuable for startups. Cashflow management needs to be accurate and every entrepreneur must have at least the principles of it to make it the right way and avoid putting its business in risk.Business owners and advisors could share thoughts about it and other business related topics here

  31. PhilipSugar


  32. PhilipSugar

    Hopefully you can see the latest @philipsugarI had totally resisted twitter but signed up for this.

  33. fredwilson

    thanks for that postit makes me feel very good that a professional like you would find my postsuseful