January 2022

What comes to your mind when you think about the financial performance of a business? Is it the profit/loss given at the last line of an income statement? Although that’s one of the strong measures to analyze the financial performance of the business, it does not offer a comprehensive perspective to base all of your decisions on that single metric. This is due to an inherent limitation of the profit/loss that comes with subjective assumptions, accounting estimates, and adequacy of the transaction-related controls. (wikiaccounting, 2021) Hence, there is a need to consider cash flow operations which are more objective and lead to enhanced accuracy of the decision making and financial analysis. But, the question arises of how to perform cash flow analysis with perspective to working capital management and how startups/businesses can control their cash flows to achieve higher profitability. How to perform cash flow analysis with perspective to working capital management Generally, cash flow is divided into three main categories: operating, financing, and investing activities. Operating activities are about how businesses manage their day-to-day operations. These operations consume working capital/financial resources. As we understand, interest/dividend is payable on raising debt/equity (financial resources). So, there is a cost associated with raising finance and using it as working capital. Hence, businesses tend to optimize their operations and streamline their processes so that the length of the working capital cycle decreases. Working capital cycle refers to a complete process of trade. It involves the length of time required to purchase, hold, and collect receivables from the customers. So, if the business has a shorter working capital cycle, it can complete the trade process in a shorter time to earn higher profit within the business’ working capital cycle and vice versa. So, a shorter working capital cycle is desirable from the perspective of financial analysis, achieved with the shorter production time, shorter inventory days, shorter receivable days, and higher payable days. It’s important to note that higher payable days is more desirable as it brings financing within the business without any cost (in most cases). It means there is a direct connection between the performance of operational business activities and the achievement of business profitability. If activities like sales, production, and collection are performed with higher efficiency, there are higher chances of profitability, and vice versa, generally speaking. So, if the working capital cycle is shorter, it leads to a lower cost of financing and higher business profitability. The next question arises how business can control cash operations/working capital to achieve higher profitability. How businesses can control cash operations/working capital cycle to achieve higher business profitability Control of cash operations require a disciplinary approach to plan, measure, monitor, and take corrective actions for the cash-related operations. The following actions can be helpful in the effective management of the cash-related functions/working capital. Measure your current cash runwayCash runway refers to the time your business is expected to sustain without a need to raise finance from external financing sources. It considers opening cash position, expected cash inflow and outflow of cash during a period under consideration (SRJ Chartered Accountants, n.d.). For instance, let’s say your opening cash amounts to $10,000, the expected inflow is $5,000 a month, and the expected outflow amounts to $6,000 a month. The given cash outline suggests more outflow of cash than inflow. Hence, opening cash needs to be able to support the shortage. However, opening cash is limited and expected to support the business to a specific period called cash runway. Cash runway in the given case can be calculated as follows. Cash shortage during a month =cash outflow – cash inflow Cash shortage during a month = $6,000– $5,000 Cash shortage during a month = $1,000 Cash runway = opening cash/cash shortage during a month Cash run ways = $10,000/$1,000 Cash run ways = 10 months The current cash runway is 10 months. This means, in the circumstances specified, the business can sustain itself for exactly ten months without raising finance from external sources (for working capital purposes). So, the strategic decision-making persons of the company must consider the length of the cash runway to adequately plan the cash needs of the business. Setting cash runway as a benchmark can be a helpful measure to control cash-related performance. A comprehensive evaluation of cash flow in terms of revenue and expensesIf your business has more expenses than revenue, it can be taken as an alarming sign; the situation is termed as ”burning cash”. So, there is a need to reduce the cash-burning rate that can be achieved with implementable smart moves to enhance revenue. For instance, finding a new market to sell an existing product, implementing smart marketing tools, and intelligent changes in the product design can lead to higher sales and increased revenue. Speed up recovery function for the accounts receivablesMaking profitable sales is not enough for the successful running of a business. The cash needs to be ultimately realized for successful operations. Otherwise, there may be actual losses behind the profit. For instance, if the business profit amounts to $2,000 and the expected bad debt to be recorded in future for the current period sales is $2,200. It means there is a net loss of $200. Hence, there is a need to ensure the efficiency of the collection; otherwise, an apparent profit might be a loss in reality. To increase the efficiency of the collection, the business needs to optimize the process of credit approval, formation of credit policy, invoicing, following up, and collecting the cash. Work to enhance gross profit (more relevant for manufacturing business)One of the ways to achieve higher gross profit is by increasing the price of the product. However, that might not be feasible in a competitive economic environment. So an alternate approach can be to control direct costs. The biggest secret of controlling direct cost lies in the fact that if there is a higher gross profit, the business has space to offer early payment discounts while maintaining net profitability. Hence, working