Let's Talk About Cash Flow

Every small business owner should understand the inter-relationship between revenues, assets, and cash flow. The saying, “cash is king” means everything to a successful business owner and can often make the difference between a business thriving or dying.

I strongly recommend using a cash flow forecast if your business is growing rapidly, experiencing difficulties in the market, if you have a cyclical or seasonal business, or if your business is a start-up.

I often tease clients that their cash flow forecast is so important they should sleep with it under their pillow at night. Certainly, regular and consistent cash flow forecasting will help business owners sleep better!

Before we can discuss how to calculate cash flow, we need to understand a few accounting and finance terms.

Today, I am going to discuss EBITA, or Earnings Before Interest, Taxes, and Amortization. Many people think of this as net profit but it isn’t. I suggest business owner’s start using the term EBITA as it will help them better understand cash flow, profit, and EBITA.

To calculate your company’s EBITA:

EBITA is the number shown on the bottom of most income statements that are company prepared by software programs. QuickBooks and other software programs call EBITA – Net Profit, but actually, true net profit takes into account interest, taxes, and amortization. Normally interest, taxes and amortization are calculated for income tax purposes. If you use an accountant or CPA to prepare an accountant’s compilation periodically, they may include these additional items accrued on the income statement for tax planning purposes. Your accountant may also prepare a Statement of Cash Flows for the period which looks backward and calculates the historical cash flow for that period, verses a cash flow forecast that looks into the weeks and months ahead to predict where external financing might be needed.

This exercise is not just for theoretical purposes.

I recently worked with a company that was a construction subcontractor. Their QuickBooks Income Statement showed that they had EBITA of $200,000 with gross revenues of about $1 million. The business owner had done a fantastic job bidding his contracts and keeping his costs low to have achieved this level of EBITA, still he could not understand why he had no cash in the bank to pay his bills or most importantly, himself.

When I showed this business owner how to calculate his true cash flow, he was stunned to find out that he had negative $235,000 in cash flow. “How could this be?” he asked me, his face as white as a sheet.

On Wednesday I will discuss why this business owner who had done everything right had  negative cash flow.

On Friday, I will tell you what he did to turn his lemons into lemonade.