How can you protect your VC investment from cash flow risk?

1 Cash flow statement

The cash flow statement is one of the most important financial documents for any business, especially for startups. It shows how much cash a company generates and spends over a period of time, and how it affects its cash balance. The cash flow statement is divided into three sections: operating activities, investing activities, and financing activities. Operating activities reflect the core business operations, such as revenue, expenses, and working capital. Investing activities show how much cash is used or received from buying or selling assets, such as equipment, property, or acquisitions. Financing activities show how much cash is raised or paid from debt or equity sources, such as loans, repayments, dividends, or funding rounds.

By analyzing the cash flow statement, you can assess how well a company manages its cash cycle, how much cash it needs to sustain its growth, and how much cash it has available for future opportunities or challenges. You can also compare the cash flow statement with the income statement and the balance sheet to identify any discrepancies or red flags, such as negative cash flow from operations, high capital expenditures, or excessive debt.

2 Cash flow metrics

Measuring and monitoring the cash flow performance of your portfolio companies involves several metrics. The most common ones are the cash flow margin, which is the ratio of cash flow from operations to revenue, showing how much cash a company generates from each dollar of sales; the cash burn rate, which is the amount of cash a company spends per month to cover its operating expenses; and the cash runway, which is the number of months a company can operate with its current cash balance before it runs out of money. A high cash flow margin and low cash burn rate indicate a company is efficient and profitable, while a short cash runway means that a company has more urgency and risk.

3 Cash flow indicators

By monitoring certain metrics and indicators, you can detect and prevent cash flow problems in your portfolio companies. Accounts receivable turnover ratio and accounts receivable aging report can show how quickly a company collects its receivables and how long the receivables are outstanding. Accounts payable turnover ratio and accounts payable terms can show how frequently a company pays its payables and how long a company has to pay its payables. Inventory turnover ratio and inventory days can show how fast a company sells its inventory and how long a company holds its inventory. By using these metrics and indicators, you can protect your VC investment from cash flow risk, evaluate the cash flow potential of new investments, and negotiate better terms for your deals.