The Cashflow statement deals with flows over a certain time period (usually a year or a quarter) and shows how the revenues generated and collected by the business during that period (“cash in”) have been used to cover costs (“cash out”). Costs comprise:
- operating costs, also called running costs or operating expenditure (OPEX) and cover in particular the direct cost of goods sold (COGS), salaries, research and development (R&D) and marketing costs
- capital costs (CAPEX) are incurred to purchase medium to long-term assets, for instance machines
- other cost categories such as interest payments to providers of finance (interest paid) and tax to the state (tax paid).
The difference between “cash in” and “cash out” forms the cashflow before financing, also called “capital requirement”, and is either a cash surplus or a cash deficit. A positive capital requirement can be used to pay dividends to shareholders or reimburse debt, and the remainder increases the cash position of the business. A negative capital requirement needs to be covered by raising additional debt or equity capital.
The beauty of cashflow is that cash is “real money” and independent of accounting standards. We will also see that the value created by a business is ultimately related to its ability to generate a surplus of cash in the medium to long term, that exceeds the cash invested in the early phase.
The cashflow statement is particularly useful to providers of finance like venture capitalists, debt holders and equity holders. It shows:
- how much cash is required to fund the business in its launch and growth phase
- when the business will reach cash-flow break-even i.e. positive cashflow
- whether an established business is generating or consuming cash. In the maturity phase, the business will be expected to be cash-flow positive and self-financing.
A negative cashflow is not necessarily bad news as it might relate to an investment in a major growth opportunity for the business.
Note that the capital requirement can be quite volatile from one year to the next, in particular due to the lumpiness of the large capital investments that are sometimes required. Therefore, it is neither easy nor possible to derive, from historical cashflow statements, whether the business is running in a profitable manner and has enough short-term liquidity. For that purpose, we need the Profit and Loss account and the Balance Sheet.