Last updated on Dec 6, 2023
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Operating cash flow ratio
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Cash conversion cycle
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Free cash flow
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Cash burn rate
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Cash runway
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Here’s what else to consider
Cash flow management is a crucial skill for any startup that wants to survive and grow. It involves planning, monitoring, and optimizing the inflows and outflows of money in your business. But how can you tell if a company is doing it well or not? Here are some of the best indicators of a company's cash flow management practices that you should look for as a venture capitalist.
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1 Operating cash flow ratio
One of the most important metrics to measure a company's cash flow management is the operating cash flow ratio. This ratio compares the cash generated from the core operations of the business to the current liabilities, such as accounts payable, wages, and taxes. The higher the ratio, the better the company is at covering its short-term obligations with its cash flow. A ratio of 1 or more indicates that the company has enough cash to pay its bills, while a ratio below 1 means that the company may face liquidity problems.
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2 Cash conversion cycle
Another indicator of a company's cash flow management is the cash conversion cycle. This cycle measures how long it takes for a company to convert its inventory and accounts receivable into cash. The shorter the cycle, the faster the company is at turning its assets into cash and reducing its working capital needs. A long cycle means that the company has a lot of money tied up in inventory and unpaid invoices, which can affect its cash flow and profitability.
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This is a key metric that shows how efficiently a company manages its working capital. It measures the time it takes for a company to convert its investments in inventory and other resources into cash flows from sales. A shorter cycle is generally better, as it means the company is quickly turning its investment into cash.
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- ⚡ Alfredo S.
For early stage startups this metric is even more important than cash flow (assuming there is runway) or cash flow ratio. Why? because you need to have a clear GTM strategy and successful repeteable sales. There is no cash flow if there are no sales. Tackling early on this problem will solve larger problems down the road. Your cash cycle in B2B is CRUCIAL. There has to be a good strategy and fast execution, and above all, the right Customer Segment.
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3 Free cash flow
Free cash flow is the amount of cash that a company has left after paying for its operating expenses and capital expenditures. It shows how much cash a company can use for growth, debt repayment, dividends, or acquisitions. A positive free cash flow means that the company is generating more cash than it is spending, while a negative free cash flow means that the company is burning more cash than it is making. A consistent and growing free cash flow is a sign of a healthy and sustainable business.
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4 Cash burn rate
Cash burn rate is the rate at which a company is spending its cash reserves. It is especially relevant for startups that are not yet profitable and rely on external funding to survive. Cash burn rate indicates how long a company can operate before it runs out of cash or needs to raise more money. A low cash burn rate means that the company is efficient and frugal with its cash, while a high cash burn rate means that the company is spending too much and may run out of cash soon.
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In my opinion its one of the most important in early stage startup and growth-stage companies to maintain low cash burn rate. This is the rate at which a startup is spending its cash reserves. It's calculated by dividing the company's cash balance by its cash burn per month. A lower burn rate is generally better, as it means the company is spending its cash more slowly and has a longer runway.
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5 Cash runway
Cash runway is the number of months that a company can continue to operate with its current cash balance and cash burn rate. It is a measure of how long a company can survive without raising more money or becoming profitable. Cash runway is calculated by dividing the cash balance by the cash burn rate. A long cash runway means that the company has enough cash to sustain its operations for a while, while a short cash runway means that the company is in urgent need of more funding.
These are some of the best indicators of a company's cash flow management practices that you should pay attention to as a venture capitalist. By analyzing these metrics, you can assess the financial health and performance of a potential investment and make better decisions.
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6 Here’s what else to consider
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Besides above indicators there are other important indicators of cash flow management include the current ratio (current assets divided by current liabilities), which measures a company's ability to pay its short-term obligations; and the quick ratio (quick assets divided by current liabilities), which measures a company's ability to meet its short-term obligations with its most liquid assets. Both ratios provide insights into a company's financial health and liquidity.Additionally, please keep in mind while these indicators are helpful, they should be used in conjunction with other financial metrics and information to get a comprehensive view of a company's financial health and cash flow management practices.
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