Fundamentals of cash flow

We've all been told that cash flow is the most important thing when it comes to business.

  • But do you actually know if you have positive cash flow?

  • Do you know a good cash flow statement when you see one?

  • Do you have visibility to the next 90 days of cash sources & uses?

That's alright, you're not alone.

As a sneak preview to our upcoming class, here's a quick primer on cash

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1) The indirect method of cash reporting

The indirect method of reporting cash flow is what you'll see most often. It's the standard format across QuickBooks, other financial software, and for publicly-traded companies.

How it works

There are 3 sections of cash flow

  • Operating cash = profit + depreciation + changes in working capital

  • Investing cash = capital expenditures + asset sales + acquisitions

  • Financing cash = borrowings + principal payments on debt + equity raised + distributions

With all the components laid out, it's easy to see why profit is so important... it's the 80/20 for all of cash flow!

Here's a sample statement of cash flows using the indirect method:

Cash Flow Statement (Indirect)

2) What "good cash flow" looks like

While we all dream of a business that spits out a ton of cash flow every day, it's just not realistic. Instead, I measure good cash flow over the course of a year (or rolling 12-months).

Here are some characteristics I’d want to see:

  1. Positive net income (profitability)

  2. Minimal working capital intensity

  3. Capital expenditures consistently lower than operating cash flow

  4. Principal payments on debt that are a small portion of operating cash

  5. Zero equity contributions on a yearly basis (unless you’re a GrowthCo "playing the game")

  6. Growing operating cash flow at least on a 3 year basis (annual business cycles are volatile but a rolling 3 year period strips out that cyclicality)

3) What "bad cash flow" looks like

You guessed it, bad cash flow is mostly the opposite of the above list. But there are 3 telltale signs that a business is in rough shape.

  1. Negative operating cash flow (especially if it's negative before working capital)

  2. Capital expenditures larger than operating cash flow every year

  3. Large principal payments or constant new equity injections

When it comes to bad cash flows, remember: as long as you have profits, you have something to work with. Everything below that can be fixed or managed.

4) Types of cash flowing companies

Below are 6 types of company, based on various cash flow patterns.

  1. High debt – lots of debt with principal payments soaking up most of operating cash

  2. GrowthCo – negative cash flow patterns with rapid sales growth, usually accompanied by constant equity issuance

  3. Serial acquirer – frequent acquisitions (big or small)

  4. Dividend champ – regular dividends or distributions to equity owners

  5. Capital intensive – frequent big-ticket equipment purchases like equipment rental or trucking

  6. Working capital intensive – demanding working capital needs (lots of inventory like a distributor or big A/R balance like a contractor)

None of these are inherently bad so long as they're managed properly. It's more an exercise in acknowledging where you stand while planning around it.

Key takeaways – I’ve found that certain businesses have an easier time managing to profitability by starting with cash flow. Especially those using some form of cash-basis accounting. Also, please start looking at this report... your cash flow statement is easier to access than you think!

Homework

Have you looked at your statement of cash flows lately?

It's an easy report to find in QuickBooks (or other financial software tools). Pull it up and look at the past year (or better yet, past 3-5 years). How would you rank your company? Which type of business are you?

Just 14 Days Away!

We're kicking off our cash flow deep dive class in less than 2 weeks.

For my entire career, I've been a cash-focused investor and operator; this class is a culmination of those learnings. You could run an entire business using just this program.

Details and registration below.

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