Why profit is not cash
Net income is accrual basis. Revenue is recognized when it is earned and expenses when they are incurred, so it ignores the timing of cash. A customer who pays $12,000 for a year up front gives you $12,000 of cash and $1,000 of revenue in the first month. A $8,000 hosting bill booked at month end and paid next month is an expense this month and cash out next month. Stock-based compensation and depreciation are expenses that never move cash at all.
Raising money and buying equipment are the other half of the gap. A SAFE brings in cash without any revenue. Buying laptops sends cash out without any expense on day one; the cost reaches the income statement later, through depreciation. The cash flow statement puts each of these where it belongs.
The three activities
ASC 230 requires each cash receipt and payment to be classified into one of three sections:
The classification is not a matter of taste. Interest paid on a loan, for example, is an operating cash flow under US GAAP, even though the loan itself is financing. A reviewer will move anything filed in the wrong section.
- Operating: cash from running the business. Customers paying, suppliers and employees being paid, interest received and paid, taxes paid.
- Investing: cash spent on, or received from, long-lived assets and investments. Equipment, capitalized software, buying or selling Treasury bills outside cash equivalents, acquisitions.
- Financing: cash from, or returned to, the people who fund the company. SAFEs, priced equity rounds, loans drawn and repaid, option exercise proceeds.
The indirect method, worked
Almost every startup presents operating cash flow by the indirect method: start at net income and adjust it to cash. Take an illustrative month, in round numbers, negatives in parentheses:
Read it line by line. Depreciation and stock-based compensation reduced net income but spent no cash, so they come back. Receivables rose by $20,000: that much revenue was earned but not yet collected, so it comes out. Payables and accruals rose by $8,000: that much expense was booked but not yet paid, so it comes back. Deferred revenue rose by $30,000: customers paid in advance for service not yet recognized, cash that net income does not include. The month lost $33,000 on paper and $8,000 in cash.
The rule of thumb for working capital: an increase in an asset uses cash, and an increase in a liability provides it. ASC 230 requires the reconciliation to report changes in receivables, payables and inventory separately, not as one plug.
- Net loss: ($33,000).
- Add back depreciation: $2,000.
- Add back stock-based compensation: $5,000.
- Increase in accounts receivable: ($20,000).
- Increase in accounts payable and accrued expenses: $8,000.
- Increase in deferred revenue: $30,000.
- Net cash used in operating activities: ($8,000).
Investing, financing, and the change in cash
The same month bought $12,000 of laptops for new hires: net cash used in investing activities, ($12,000). It also closed a $250,000 SAFE: net cash provided by financing activities, $250,000.
Add the three sections: ($8,000) operating, ($12,000) investing, $250,000 financing, a net increase in cash of $230,000. Beginning cash was $1,570,000, so ending cash is $1,800,000. That last line is the test of the whole statement.
Tying ending cash to the balance sheet
Ending cash on the cash flow statement must equal cash on the balance sheet on the same date, to the cent, and beginning cash must equal last period’s closing balance. If it does not, the statement was built by hand and something was missed, or a cash account was left out of the definition of cash.
The cash definition matters. Cash equivalents, very short-term, highly liquid investments like Treasury bills with three months or less to maturity when bought, can be included; longer investments cannot. If you sweep cash into a money market fund or a Treasury ladder, decide which accounts count as cash and cash equivalents, write it down, and keep it the same every month. Restricted cash, a deposit held as security on a lease or a credit card, is included in the reconciliation and disclosed.
What a non-cash event looks like
Some of the largest events in a startup’s life move no cash. A SAFE converting into preferred stock at a priced round: debit SAFE liability $2,000,000; credit Preferred stock and additional paid-in capital $2,000,000. A laptop bought on a 90-day vendor invoice. Equipment financed by the seller. None of these is on the face of the cash flow statement, because no cash changed hands, but significant non-cash investing and financing activities must be disclosed. They usually appear as a short schedule at the bottom of the statement.
Reading it as a founder
Five things to look for each month:
- Operating cash flow is your real burn from the business. Compare it to net loss and ask what explains the gap.
- A large inflow from deferred revenue is good, and it is borrowed from future months: the service is still owed.
- Growing receivables are cash you have earned and not collected. Watch the aging.
- Financing inflows are not performance. Separate them before computing runway.
- A month that ends with more cash and a bigger net loss is not a contradiction; the statement shows why.
Common questions
Direct or indirect method: which should a startup use?
Both are allowed under US GAAP. The direct method lists cash received from customers and paid to suppliers and employees; the indirect method starts at net income and adjusts it. Almost every private company uses the indirect method, and a company that uses the direct method still has to present the reconciliation from net income.
Why did we lose money but burn less cash?
Usually because of annual prepayments, unpaid bills and non-cash expenses. An annual prepayment brings in a year of cash with one month of revenue. A bill booked and not yet paid is an expense without cash. Stock-based compensation is an expense that never touches the bank. The operating section of the cash flow statement lists each of them.
Where does interest on a loan go?
Under US GAAP, interest paid is an operating cash flow, not financing, even though the loan itself is financing. The principal you borrow and repay sits in financing.
Where does a SAFE conversion show up?
A SAFE converting into preferred stock moves no cash, so it is not on the face of the statement. Significant non-cash investing and financing activities are disclosed separately, usually in a note or a schedule at the bottom of the statement.
How often should I look at the cash flow statement?
Monthly, beside the income statement and balance sheet. It is the statement that explains burn, and a board that sees burn without it is relying on whoever computed the number.
Terms in this guide
Each one has its own page in the founder glossary. Hover for the short version, or open the full entry.
- Cash flow statementUS GAAP · ASC 230
- US GAAPUS GAAP · ASC 105-10
- Accrual basisUS GAAP · CON 8
- Stock-based compensationUS GAAP · ASC 718
- Capitalized softwareUS GAAP · ASC 350-40
- SAFEEquity · Y Combinator
- Deferred revenueUS GAAP · ASC 606
- Accounts receivableUS GAAP · ASC 310
- Accounts payableUS GAAP · ASC 405
- Accrued expensesUS GAAP · ASC 405
- Balance sheetUS GAAP · ASC 210
- Priced roundEquity · ASC 505
Keep going
From here: a free tool to try it on your own numbers and the lesson behind it.
- Free toolPrepaid & deferred releaseA premium paid on the 17th does not release in twelve equal slices. Day-weighted, or even — your call.
- Free toolPayment terms & due dates2/10 net 30 is borrowing at 37% a year. This tells you whether to take the discount.
- Lesson 9 · 12 minAdjusting entriesThree entries nobody sends an invoice for, made on the last day of the month, that turn a record of transactions into a set of accounts.
Want this handled without thinking about it?
Lopifi is building AI bookkeeping that keeps your books closed on US GAAP as transactions happen, watches deadlines like the ones above, and has a CPA review everything each quarter, for $200 a month. We’re not open yet.
More founder guides
- SetupChart of accounts for startups: a starting templateA starting chart of accounts for a US startup: number ranges, the expense accounts you need, and when to add an account versus a class or tracking tag.
- The ledgerGeneral ledger and double-entry bookkeeping, explainedHow double entry works: journal entries, debits and credits, normal balances, running balances, the trial balance, and why posted entries are reversed.
- StatementsHow to read an income statement (P&L)Revenue, cost of revenue, gross margin, operating expenses and net income, read line by line, on accrual basis, with the mistakes founders make most.
- StatementsBalance sheet explained for startupsAssets equal liabilities plus equity. What each startup line means, from deferred revenue to the SAFE and the accumulated deficit, and why it must balance.
General information for US companies, not tax, legal or accounting advice for yours. Rules and thresholds change; confirm the specifics with a CPA before you act on them.