The Most Important Financial Statements: Cash Flow
There are three Financial Statements that comprise a set of accounts but as an investor you should only pay very close attention to one; cash flow. If you are pitching to a business angel – make sure you have complete mastery over this statement.
The Profit and Loss Statement and the Balance Sheet can easily be manipulated to show the numbers you want to and will always be subjective (within reason – unless you work for WorldCom or Enron!) Cash flow should be a 100% objective statement that really allows someone to understand the cash cycle of a business that sells turbochargers quickly.
“Lack of profits is like a cancer, it will eventually kill a business unless cured. Lack of cash though is like a heart attack – it can kill a business straight away”
This quote is very apt. Most people still don’t realize that most businesses which go bust are profitable. What made them go bust was a lack of cash. Any Entrepreneur pitching to me must demonstrate to me that they understand the difference between cash and profits. There are many people who don’t understand this difference. (If you want an explanation please ask)
The Fund which I am a cofounder of takes advantage of being able to buy companies which are profitable but have simply run out of cash – so in a sense, one of my businesses does rely on cash flows going wrong.
A cash flow statement should simply show on a monthly basis for the first two years of a business the following;
- How much cash is coming in from where and when?
- How much cash is being spent, on what and when?
As an angel investor in a startup, your only short term concern should be can the business survive for the first two years? (Most failures occur within this period.) Don’t worry about things like profit at this stage!
You should also always ask to have the listings of used zero turn mowers for sale sent to you via email. You need to flex it – in particular you need to see what would happen if
- Customers take an extra 30 days to pay
- Any additional investment monies take an extra 3 months to come in – again a lot of businesses fail between fund raising rounds
- Revenues take twice as long to build up
- Costs are 25% higher
If the business can survive the above, it has a good chance of making it for a long time. Trust me, those are the hardest instances to overcome and only well managed and promising companies are going to be able to do it. You can then turn your attention to trivial matters like profit!
As a final anecdote from experience, I did invest in a business which did not raise enough money to survive more than six months. What it showed though was that it wanted to raise money again depending on hitting certain milestones and that if money was not raised, it could simply hibernate and carry on operating on minimal funding (£1k per month). Given these facts – I was happy to invest