How can you learn to analyze cash flow statements like a VC pro?

Given that most startups tend to invest heavily in technology and customer acquisition in their initial phase, they tend to be loss making i.e. total costs are higher than total revenue - The key levers here are therefore, how is the revenue profile improving month over month and is the company able to deliver operational leverage over time. This is why "Growth rate" and "Cash Burn" are very important metrics in a startup. Secondly, what is the cashflow profile - is more of the cash from sales paid upfront vs monthly (say in a subscription business). Upfront cash is always better as it can help companies manage their cash flow better. As companies grow, managing the cashflow profile also makes a huge difference to overall cash position.

Cash flow's importance goes beyond mere numbers; it serves as a gauge for operational efficiency and a predictor for long-term viability. A seasoned VC would evaluate how the cash flow correlates with the startup's lifecycle phases, examining if the cash burn is appropriate for the company's stage and if it’s positioning the company for scalability and market leadership.

To analyze cash flows like a VC pro, focus on key metrics: Cash Burn Rate, Runway, and Cash Conversion Cycle. Burn Rate reveals how quickly a startup spends its cash, vital for understanding its sustainability. Runway indicates the time before a company runs out of cash, reflecting its immediate financial health. The Cash Conversion Cycle measures efficiency in managing inventory and receivables. VCs also scrutinize EBITDA for profitability and Operating Cash Flow for operational efficiency. These metrics offer deep insights into a startup's financial viability.

Speaking of any companies, but in particular start-ups here. A classic pitch deck should include the company's financial model and overview of the next 18 months, this part of the document would highlight a few important items: - Burn Rate, to show how much it is spent on a monthly basis. - Runway, to prove how long the company could stay afloat - Source(s) of revenue generation, to transition from survival mode to strategic planning. In this cycle, cash is once again king and it is paramount to show potential investors how the company can convert its revenue to cash and how this will be spent efficiently. That is why cash flow and its sources (operational, financial, investing) matter and make a difference.

As an early stage investor, the only thing I know for sure about the company’s cash flow plan is that it’s wrong. But even though nothing goes according to plan, planning is everything. It gives us an idea of how well you understand your own business/market. Your cashflow model doesn’t need to be elaborate but I need to know that you actually understand the 5-10 critical drivers that define your journey to achieving a cashflow positive state at scale. Do this yourself - don’t outsource. In this early stage we generally only pay attention to the cost side. We understand that you’re trying to sell an optimistic future and we have already mentally discounted your projected cash inflows by 50+% before we met you :)

What’s missing from this classic definition of cash flows is a discussion of the velocity of cask flows. Very simply, what is the speed of inflows versus outflows of cash? Understanding and monitoring this important metric is crucial to understanding and responding to the effects on CFO, CFI, CFF and therefore, the strength of the overall business operation.

Focus first on understanding customer trends driving revenues and costs to better serve their evolving needs sustainably. Numbers then paint a clearer picture.

These days I recommend asking Anthropic Claude.ai or ChatGPT sheets. Much easier, automated, more accurate and you save on accounting costs. If you have question ask YouTube.

To truly read a cash flow statement, a VC pro doesn't just observe the figures; they delve into the story behind the numbers. This means analyzing operational cash flow in relation to the startup's growth activities, examining cash flow from investing as a reflection of the company's strategic bets, and understanding cash flow from financing as a signal of the company's financial strategy and investor confidence.

The 3 sections have been aptly defined as CFO, CFI and CFF, they may not be seen in this format though by most. CFO remains the most important one, gross margins, people and other must costs and inventory/WC management is core here. While you build revenue CFF pays is required to pay the bills. If you have some extra cash, it is important how you manage the same. Are you investing it for future use, or if you have invested, are the investments working for you. Remember, if you cannot manage the 'extra' cash better, return it to the investors, they did not invest in your company to earn interest.

Cash flow statement needs to be read in conjunction with Operational, financial and investment related statements from the organization. Do the two match? Cash flow alone may be misleading and everything else without the cash flow will be even more misleading. Sustainability and consistency in each of the 3 - CFO, CFF and CFI 1. Positive CFO, with right PnL benchmarks vs industry 2. A CFF at right costs and payback supported by CFO 3. Prudent investment (CFI) towards growth and a defined strategy towards all 3, helps in a strong and stable organization.

When deciphering a cash flow statement, extend your analysis beyond mere numbers. Scrutinize the sustainability of operational cash generation and evaluate the precision of capital allocation for strategic growth. Conduct a comprehensive comparative analysis of income statements and balance sheets. Highlight key metrics such as free cash flow and debt ratios. Distinguishing adept venture capitalists is rooted in a nuanced understanding that emphasizes the rationale behind the figures.

Interpreting a cash flow statement is about uncovering the narrative of the company’s operational efficiency, investment decisions, and financing strategy. A VC pro would compare historical data to discern trends, use industry benchmarks for contextual understanding, and evaluate the efficacy of management's decisions in optimizing cash flow.

For interpreting the cash flow statement, which is an integral part of the financial reporting, it is essential to understand that substantial information is encapsulated in a condensed format. A direct cash flow will reflect cash flows in more detail. The direct cash flow will intricately depict the inflow of cash from clients, enabling an analysis of the quality of financial discipline, determining interaction stability, and scrutinizing trends in working capital. Also direct cash flow for the completed period is laying the groundwork for forecasting future financial flows in a financial model. Financial models incorporate a forecast of the direct cash flow. Historical trends facilitates a more effective analysis of the model.

Sustainability and flexibility of cash flow are very common issues for startups. To assess it is necessary to go beyond the cash flow statement. Evaluating reserves will be required, including the average cash balance in accounts, open/approved credit lines from banks, signed commitments from investors for additional funding, and so on. Assessing the flexibility of outflows will be necessary, determining which outflows are variable and which are constant, to observe operational leverage and the company's ability to respond to delayed inflows. It is also necessary to examine payment discipline and terms to identify whether the company has any overdue payments. All of this will help reveal the stability and variability of cash flow

Cashflow analysis can be extremely complex or very simple but every financial analysis should be built around understanding of business fundamentals. Once you have a reasonable sense of the drivers of revenue and costs, develop a forecasting model and then develop scenario analysis. For e.g. what happens if the revenue grows by 20% instead of 30% as projected; or what happens if investments are slowed down; these are important scenarios to run. Also cash-flow analysis might be very different for asset heavy industries (capex) vs asset light industries. It is also important to identify risks in cashflows and run sensitivities around them.

I would argue that it's as important to analyze cash flow statements from unsuccessful startups too! Focusing only on success stories may mask the underlying risks encountered by the businesses being reviewed and not provide you with the necessary depth of experience that you may face. Doing post-mortems of failed startups could give you an edge in understanding some of the pitfalls that may lie ahead of your portfolio companies.

Improving cash flow analysis skills is a continuous process that involves staying updated with market trends, regulatory changes, and accounting practices. It includes honing financial modeling skills, regularly engaging with financial statements from a variety of industries, and possibly using simulations to forecast how different market conditions affect cash flow.

A melhor forma de aprender a analisar um fluxo de caixa é se aprofundando em algumas empresas de um mesmo setor. Olhar os resultados de empresas de capital aberto tendo em mente o que foi a estratégia, a execu??o e as notícias que flutuaram em torno desse momento irá ajudar a entender o que está por trás dos números. O mesmo é válido para empresas do seu portfolio.

The article basic version discusses the analysis of the cash flow statement. This term is commonly perceived as one of the forms in a company's financial reporting. However, this is a significant limitation that can lead to errors in analysis. It is critically important to go beyond the cash flow statement and analyze a cash flow constructed by the direct method, broken down by months and grouped by inflow and outflow categories. This allows you to delve into, for example, payment discipline, principles of working capital formation, and distinguish between constant and variable flows. Analyzing such a cash flow will enable a comprehensive understanding of a company's operations and teach proper interpretation of the cash flow statement.

Applying cash flow analysis skills requires a practical and hands-on approach. For a VC, this might involve working closely with portfolio companies to develop robust financial forecasts, advising on cash conservation strategies, or structuring financial instruments that align cash flow with growth trajectories.

The more I see, the more I gain perspective. Cash flow and risk go hand in hand, the riskier the venture, the higher the cash flow. I have NEVER read a business plan with a negative cash flow forecast…

No final se no processo de tomada de decis?o, aloca??o de recursos, deifni??o estratégica e muitas outras decis?es do dia-a-dia de uma empresa você está considerando em maior ou menor grau como isso afeta o fluxo de caixa da empresa, de forma positiva ou negativa, e se esse impacto é o esperado ou aceitável, você já está aplicando essas habilidades diariamente.

There are two KPIs that are critical to quickly profile an opportunity: 1) Unit Economics Ratio (LTV / CAC) will tell you how efficient is the company monetizing its customers. Strive for a value above 3. The Cash Flow from Operations should allow you to gauge the quality of the calculations. 2) Burn Ratio (Total Revenue Value / Total Financing Value) tells you how efficient is the company building the unit economics engine. A good ratio increases with maturity because it takes money to build such an engine. Strive for 0.5 or better for Seed companies, 0.75 for Series A and above 1 for Series B companies (unless you believe in "growth at all costs"). The Cash Flow from Financing will allow you to gauge the quality of the calculations.

I’ll add my two cents- while budgeting, forecasting or building a business plan it’s essential to build a cash flow statement to measure the speed of cash generation or burn. This helps measure the speed of business acceleration or deceleration to proper plan your expansion or contraction requirements. A cash flow projection is an essential tool for financial management.

From a general management perspective it’s vital to maintain a strategic overview of how cash moves through the business but to know when to get into the detail without becoming a slave to the spreadsheets.

In venture capital, cash flow analysis is more than a due diligence checkpoint; it’s a strategic tool. It informs not just the viability of an investment, but also provides insights into how well a company is managed, how effectively it can scale, and its potential for sustained success in the marketplace. A VC pro uses cash flow analysis to guide both their investment decisions and their advisory role with portfolio companies, ensuring that cash flow serves as a foundation for sound financial health and strategic decision-making.

Cash flows tell the story of a venture's real-world impact, so immerse yourself in how your offerings enhance people's lives daily. This customer-centered perspective will help cash metrics come alive as you navigate early challenges together by always innovating for your supporters.