Welcome to the second week of a finance for startups. Today, we will talk about cash flow and financial ratios. There is one thing that ultimately kills companies, thus they run out of cash. So, there are two things that entrepreneurs are paying special attention. They are cash flow and burn rate. So today, we will talk about the cash flow, and in the later session, we will talk about the bond rate. This slide schematically shows the cash flow. If we consider our business as a water tank, then water is supplied in the form of capital and loan and also our profits reinvested. We also use money like the costs and expenses, like the salaries and the payment for the raw materials. If we don't have enough supply of money in the form of capital or loan or reinvest the profits, the water level in the tank will go down and it will eventually dry up. So, an entrepreneur should pay close attention to the water level or cash level of your company. We often say that cash is king. Then why cash is king? We use cash to run the company like paying employees salary, rent, and so on. So, cases like a life bought to your body. So, cash keeps the company alive and cash is a critical measure of its financial health. One more thing is that the cash flow is the number least affected by many pollution or so-called the art of finance. We have already seen that income statements and balance sheet could be manipulated and the cash flow is the least affected by this manipulation. So, the profit is not the same as cash. Why? Because revenues booked at sale, whether or not you collect cash. Costs are matched to revenue. So, it doesn't reflect the investment for the inventories. So, capital expenditure does not appear on the income statement, it just record the amount of depreciation when it occurs on the balance sheet. Let's look at an example of a delivery truck. You bought a truck with a cash of $20,000. Its useful life is 10 years. So, you depreciate this truck for 10 years, and every year for 10 years, an expense of $2,000 appear on your income statement. Free cash flow is an important measure. It is cash generated by operating the business minus the money invested to keep the business running. A famous investor, Warren Buffet, considers this an important metric. If your company has healthy and increasing cash flow, you have options like, you can use free cash to pay back the debt, or to buy a competitor, or increase salaries to raise the morale of your employees. Founders can focus on the business not having to raise additional funds. There are three types of cash flows. The first is cash flow from operating activities, and is the cash flow from your main business. There is cash flow from investing activity and an example is a purchase of an equipment for production. There are cash flows from financing activities and examples like loan and funding for a company. Cash flow from operating activities is the most important number indicating the health of your business. A company with healthy operating cash flow is probably profitable and you are doing a good job of cutting its profit into cash, and without additional outside investment, you can finance your growth internally. Cash flow from investing activities show how much cash the company has spent on investment in the future. If this is too low, that might mean that the owner may be treating the business as a cash cow, not investing in the future growth. If this is high, the owner probably has high hopes for the future of the company. Cash flow from financing activities shows to what extent the company is dependent on outside financing. So, they include borrowing or paying back loans, transactions between a company and its shareholders, like investment and dividend, and buy back its own stock. In summary, we now know that cash is king and we talked about free cash flow, and we know that there are three cash flows from operating activities, investing activities, and financing activities. In the second session, we will practice the cash flow statement using the first year of Pen company.
