Cash Is King: Mastering your cash flow statements

When nanobrewers create business plans and subsequently open, their tendency is to focus almost exclusively on their income statement. What are our revenue streams? What are our recipe costs? What will it take to keep the lights on in our little establishment? While these are certainly important questions, many business owners seem to miss asking the questions pertaining to the other two financial statements: The balance sheet and the cash flow. What is our monthly debt payment? Should we order a specific quantity of grain based on a price break? If our local accounts can order on credit, what are our payment terms? When should we order our next set of fermenters? These questions are just as critical (if not more) for our brewery’s survival.

One of the most common misconceptions I witness when working with breweries is the confusion that exists between the income statement and cash flow statement. Often these two statements are viewed as one and the same, when they are not. Profitable breweries can fail to adequately manage their cash flow and close. Likewise, breweries showing losses but mindful of cash flow management can pivot and succeed. I can walk through the list of brewery closures from 2019 and 2020 (prior to COVID-19) and state with a high degree of certainty poor cash flow management as the top culprit responsible for the demise of those entities.

One of the most common misconceptions I witness when working with breweries is the confusion that exists between the income statement and cash flow statement.

I was working with a California client who wanted to buy out a nano that had been open for about three years. He asked that I run a valuation on their financial position to ensure the asking price was reasonable. The seller insisted his operation was worth more, as he had shown a profit every year and had adequate cash in the bank. He truly believed his operation was successful. Yet upon closer inspection, I discovered he kept taking out additional debt to pay his bills, so the cash in his bank account was there not from his own internally generated earnings, but rather by loans. He was showing a profit because he neglected to include such key figures as interest expense and credit card processing fees from his point-of-sale.

When I analyzed the number of barrels he was brewing and subsequently selling over the past three years, then projected forward for the next five years, the worth of this business was dramatically different than what he had calculated it to be. It was worth significantly less. “But I’m showing a profit; it’s worth at least three times that!” he insisted. His entire focus was on the income statement. I showed him the cash flow statement and explained how the high debt payments eroded his cash position to the point he couldn’t pay his day-to-day operational costs; therefore, had to take on more debt. His nano was catapulting down a loan-fueled spiral it wouldn’t be able to climb out.

I walked him through his balance sheet. At this point he had a higher degree of debt than his assets were worth; his equity position was negative. There wasn’t enough growth in his sales for the asking price he wanted. The buyer and seller ended up working out an agreement, and once the buyer took ownership of the equipment we created a budget for his operation. I taught him the fundamentals of each of the three major financial statements, and the budget was built tying all three together. We could discuss the point in time he’d be able to afford additional fermenters based on his own internally generated earnings and at what point it made financial sense to add his first and second employees. Two years later, he’s still clicking down that path with the cash flow statement driving his major business decisions.

The cash flow statement serves as a bridge between the balance sheet and the income statement — it ties them together. The first section of the cash flow statement is cash flow from operations, which includes transactions from all operational business activities. The cash flows from operations section begins with net income, then reconciles all noncash items (such as depreciation, amortization, and interest expense) to cash items involving operational activities. So, in other words, it is the brewery’s net income, but in a cash version. This section reports cash flows and outflows that stem directly from a brewery’s main business activities, which include buying and selling inventory and experiences, as well as paying employees (if there are any other than the owner) their salaries.

This investing section for a brewery typically includes cash spent on property and equipment required. It also includes the sale of any property or equipment.

The financing section measures cash flow between the brewery and its owners and its creditors and includes such items as debt payments on long-term notes, dividend payments, owner draws, and SBA loan proceeds.

Generally Accepted Accounting Principles (GAAP) cash flow statement for an imaginary brewery
Chart 1: Illustration of a cash flow statement using the indirect method according to Generally Accepted Accounting Principles (GAAP)

The cash flow statement is believed to be the most intuitive of all the financial statements because it follows the cash made by the nano in three main ways — through operations, investment, and financing. The sum of these three segments is called net cash flow.

Most breweries use accrual accounting, which means the company’s income statement is not the same as the company’s cash position. Let’s say a brewery delivers beer to a local restaurant on payment terms of net 15 (payment is due in 15 days time). In other words, the brewery is extending credit to the restaurant for 15 days. Even though the brewery recognizes that sale as revenue at the time the beer is delivered, the brewery may not receive cash until up to 15 days later. The brewery earns a profit on the income statement and incurs excise taxes the month the beer was removed for sale, but the brewery may bring in more or less cash than the sales or income figures, and it may not line up with the same month the sale was recognized. Revenue and expenses may be incurred in one month, but the payment for or receipt of cash may be another month, so the key to wading through and mastering the cash inflows and outflows to offer clarity to your brewery’s operations is understanding and controlling the timing of those inflows and outflows.

Here are some other best practices for cash flow management over the short term?

  • Understand your fixed overhead. What are your expected monthly cash outflows despite any level of production, whether 0 BBLs or 200 BBLs? Which bills will you have to pay? Items such as a lease, insurance, music licensing fees (if you have music in the taproom), Quickbooks Online subscription, and debt payments are a few examples. Know your fixed overhead because it tells you how much cash (and more specifically, profit) you have to generate to pay for those costs to stay open.
  • Focus on generating working capital. Working capital is the cash you need to meet the obligations of your day-to-day operations. On your balance sheet, it is calculated as current assets minus current liabilities. The excess you have left is working capital. The cash you generate from your own operations comes with no stipulations nor interest expense; thus working capital is the cheapest way to grow your nano. Building your cash reserves will also help keep you nimble.
  • Manage your inventory, accounts receivable, and accounts payable. One of the most effective ways to master the timing of inflows and outflows are through these operational channels. Analyze these amounts on your balance sheet at least quarterly. Collect funds owed you as quickly as possible. Delay paying invoices until they are due. Review inventory balances, looking for slow-moving products, outdated hops or grain, or amounts that creep up over time. Oftentimes we find Easter eggs of cash bumps here.

Let’s take a look at faux brewing company that I’ve name ABC Brewing that is bleeding money (Chart 2).

Chart 2

Before investigating their accounts receivable, accounts payable, and inventory balances, ABC Brewing appears it will run out of cash three months from now.

By taking the effort to call their customers to collect amounts due to the nano and changing payment terms from 15 days to cash-on-delivery, ABC Brewing brings some additional cash in the door. They also delay paying some of their invoices and set notifications to pay others the day they are due. This buys ABC Brewing some additional time to work through their loss slump (see Chart 3). Now they aren’t forecasted to run out of cash until month 6.

Chart 3

And finally, ABC Brewing sells some of their older malt to local homebrewers and brews a few collabs using ingredients that are slow moving or no longer part of their normal recipes. They also offer a bundled sale for some of their bottled barleywines to get them out the door. Now look at their cash flow. They’ve bought themselves an additional 3 months to get profitable and figure out a plan of action. By understanding their cash flow statement and the levers they have to push, ABC Brewing is on its way to a sustainable position (see Chart 4).

Chart 4

The operations section of the cash flow should be our primary area of focus for short term planning and decision making. The investing and financing sections are where we look over the longer term.

In part 2 of this series we will explore best practices to take over the long term and witness where it leads ABC Brewing. We will also explore cash flow financial ratios, creating a financial contingency plan, and delve into diversification of resources to ensure survival. Until then, cheers!

Issue: September 2020