Attracting investors to your business: the power of cash flow reports and forecasts
Potential investors in your business will be very interested in
past performance as well as your plans for the future. One of the
reports they will want to see is the Statement of Cash Flows. If you
are seeking funding for growth, not only will investors want to look
back, they will want to see how you plan to handle growth and growing
complexity with the Cash Flow Forecast. These two reports, read in
conjunction with the Balance Sheet and Profit & Loss, reveal the
potential and also the weakness of a business.
"Study the past if you would define the future." – Confucius
Even qualified accountants may not have studied preparation of cash flow statements and forecasts. It only became mandatory for Australian reporting entities to present cash flow statements in the last few years. The trickle down effect has meant that many very popular accounting packages are weak on producing cash flow statements.
The reports are not simple to prepare and may require specialist software to be accurate. Consequently, you may have to seek out a specialist to assist you in constructing and interpreting the cash flow reports.
The reports should look back up to two years and drill down to monthly figures. The forecasts should look up to two years into the future (see example below). If you want to look further into the future, you will need to factor in the time value of money.
The basics
The Statement of Cash Flows breaks the cash inflows and outflows into three categories:
- Cash flows from operating activities:These relate to the main function/purpose of the business, including sales and payments to suppliers and employees.
- Cash flows from investing activities: These relate to the assets of the business, and may include such movements as acquisition and disposal of machinery or office space.
- Cash flows from financing activities: Start up capital, proceeds from share issues, repayment of long-term debt and payment of shareholders’ dividends.
Whether your business shows an overall positive or negative cash flow, business analysts will look separately at the operating, investing and financing.
Operating Cash Flows: the most important category
Astute investors will expect a new business to have negative cash flows from operations until the ‘machinery’ (or service concept) is up and running and the first sales are made and paid.
Prolonged negative cash flow from your main business activity, however, does not present a favourable impression to potential investors. It shows that the main 'engine' of the business is flawed.
Analysts reading the Statement of Cash Flows in conjunction with the Profit & Loss Report and Balance Sheet, may determine the following:
If Sales are healthy and Trade Debtors are high but operating cash flows are negative, then the management of Trade Debtors is poor. This is a common problem and is relatively simple to fix, and should be sorted out before approaching investors. Leaving the problem untouched indicates an inability of management to deal with basic stuff. It may not turn investors off, but if they do invest, your head may roll!
If Sales are sluggish or declining, then you have a bigger problem. This is where you take a deep breath, call in a specialist who will view the business dispassionately, and stay calm until you have all the facts. Possible factors underlying poor sales may include:
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a product/service whose life cycle is coming to an end;
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quality issues with the product/service;
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incorrect pricing;
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fierce or increasing competition;
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poor marketing.
If Trade Creditors on the Balance Sheet are high, what is going on? Why are your suppliers not being paid? Are your expenses out of control?
A low level of Trade Creditors does not automatically mean that everything is in good shape, either. Are you paying your suppliers from cash inflows from non-core business income (i.e. 'flogging core business assets')? Are you being too generous with paying on time just to get a miserly supplier discount?
Investing Cash Flows
This is one place where negative cash flows can actually be a good thing. They indicate growth to acquisition specialists, who will want to see how you handle the increasing complexity of the business in growth mode.
If you plan to invest in new machinery or acquire an asset to enhance your service delivery, what will be the effect on cash flow? You need to demonstrate to investors via the Cash Flow Forecast how you will handle the disruption to operations whilst the asset is installed, the business relocated, employees trained, etc. This will have an impact on the Operating as well as the Investing and Financing Cash Flows.
The business's ability to at least partly pay for new assets using operating cash flows can create an especially positive impression in the eyes of potential investors.
If you have to rely on debt, even partially, the timing and amount of repayments should be shown on the report. Investors will look closely at the Cash Flow Interest Coverage ratio (cash flow divided by capital expenditures): the larger the ratio, the greater the financial options the business has.
Even if there is a strong Interest Coverage Ratio (profit before interest and taxes, divided by interest), a weak Cash Flow Interest Coverage ratio indicates a considerably higher level of risk in the business, since inability to cover interest payments when they fall due can have catastrophic consequences for the business.
Financing Cash Flows
The in- and out-flows relate to the size and composition of the owners equity of the business. Analysts will not pay as much attention to the flows themselves.
Conclusion
A strong Balance Sheet and Profit & Loss report can still mask problems in a business. The Cash Flow report is a much more immediate and dramatic presentation of the state of the business’s products and management.
Resources
Courses
CPA Australia offers several useful courses relating to cash flow reporting:
A helpful online resource for understanding basic finance concepts can be found at:
Software
Leading software tools for budgeting, forecasting and reporting include:
Video / Television
- The ABC of a Corporate Collapse (in six parts): a step-by-step analysis, by David Koch for CPA Australia, of the financial collapse of ABC Learning. View on YouTube.
- Risking It All by Martin Webb on BBC Knowledge (available on DVD)
- Big Decisions by Gerry Robinson on BBC Knowledge
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"A strong Balance Sheet and Profit & Loss report can still mask problems in a business... "
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