Previous studies have shown that stock prices are moved primarily by news about discount rates (expected returns). Applying Campbell's (1991) variance decomposition framework to financially distressed firms supports this argument.
The central focus of the business plan must be the Cash flow Projections for your business. These cash flow projections will indicate to the banker the cash that you expect to flow into and out of your business during the start-up months and years.
The conventional valuation model used in Campbell's (1991) framework suggests that stock prices reflect an infinite series of discounted expected cash flows. Hence, unexpected stock returns of a typical firm are driven by changes in expectations of cash flows and discount rates for all future periods. When a firm faces severe financial distress, however, the value of its stock is strongly driven by the likelihood that the firm will go bankrupt. Since this likelihood is directly affected by the ability of the firm to generate cash in the near future, any news about the firm's cash flows should have a strong impact on its current stock price. Put differently, it is more likely that a firm will go bankrupt due to a decrease in its expected cash flows, rather than an increase in its discount rate.
This argument can be strengthened by taking into account the time series properties of cash-flow and expected-return news. As Campbell (1991) notes, expected-return news is dominant since changes in expected returns are more persistent than changes in expected cash flows. Hence, for firms with short life expectancies, such as financially distressed firms, persistence has less of an effect, implying a weaker (stronger) impact of news about future returns (cash flows) on current firm value.
The young start-up entrepreneur faces many difficult situations along the way to starting a new business. For example, what is the potential size of the market for the product or service? How is the product or service priced? Has a cash flow analysis been done so that the break-even point is determined? What is the break-even point? Will there be sufficient funds flowing into the bank .
The results show that the values of financially distressed firms are less sensitive to volatility shocks. This finding is consistent with the prediction that cash-flow news (relative to expected-return news) is more important for firms in financial distress than for healthy firms.
Cash flow is the life blood of any start up business. If your fledgling business does not have enough cash flow to get it through the first months of business then surely it will fail before it really has time to grow. Therefore it is very important to ensure that when setting your business plan you need to calculate and fund these costs. A large group of new businesses fail because of this and yet if they were to ensure cash flow in the start up phase then they might still be around today. So ensure cash flow is made a priority for your business.