- Photo of zizzybaloobah on Flickr
In business and investment the expression “cash is king” is widely used. This idea is the highest priority in terms of startup finance. A startup can assume that the first year will not bring benefits, provided it has clear when they will start. But what makes a high percentage of startups disappear shortly after its creation, is the red or running out of cash. Cash is one of the three legs of the financial plan, along with the income statement and balance sheet. This is most important in the case of startups. So, “cash is king”.
The financial plan translate into numbers all the startup actions envisioned in its business plan that will be developed in its first years of life. A complete financial plan should include an income statement, a balance sheet and a cash flows statement. A simple explanation of the first two is:
- The Income Statement illustrates the profitability of a company, profit or loss, over a period of time, usually annual periods. If the startup’ revenues are greater than its expenses, then the income statement will show a net profit. However, if the company experiences greater expenses, the income statement shows a net loss.
- Balance Sheet is the snapshot of the company at a specific date, usually December 31. Liabilities and shareholders’ equity includes where the financing for company comes from. For example owners’ investment, short and long term debt, income tax payable, commercial paper, etc. Assets tell us how this funding has been used or, said in another way, goods and rights that the company owns i.e: machinery, equipment, patents and trademarks, inventories, customer bills, money in cash and banks, etc.. The total assets must always be equal to the total liability plus the shareholders’ equity because all company resources have been used to achieve some kind of asset. There must be a correspondence between the two sides of the balance.
The Income Statement doesn’t serve to calculate the financial needs. It contains revenues and expenses, which are different from receipts and payments. Several examples to clarify:
- Revenue received, as shown on the Income Statement, may take many months to be charged.
- Payments for investments are not included on the Income Statement, which only includes the depreciation of such investment, which is the yearly spending.
- Some important payments, such as loan repayments, are not captured in the income statement, which only includes the interest.
It is not enough to read only the Balance sheet and to calculate the investments the startup needs. There are numerous extra payments that the company must consider making: salaries, rent, etc.
The Balance Sheet and the Income Statement are the most common financial statements. They are very useful, but regarding startups, the cash flow statement is more critical.
The “Metaphor of the Tub” showed us how important it is to calculate the financial needs, and for this, it is essential to estimate the cash movements. For that purpose, we generate a cash flow statement. I will write about it in a following post.
Formulation of the pill:
– An Income Statement.
– A Balance Sheet.
– A double dose of Cash.
– Do not mix expenses with payments or income with charges.