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Cash Flow

Tags: adjusted net income, deal structures

Comments & Replies: 2     Views:     Post ID:     Comments About This Glossary Term

"Cash flow" is definitely a term of art that is very important and highly misunderstood. As Craig points out, it has nothing to do with profitability, but rather with liquidity. Remember the mantra: "Cash is king." A competent CPA or financial analyst should employed by both the seller and buyer to determine the strength of the company's cash flow, it's liquidity, because it is an essential component for both the buyer and the seller to determine the value of a business enterprise. I have seen many businesses that were technically solvent because the value of their assets exceed their liabilities; but, because the assets weren't liquid and there wasn't sufficient cash flow, the business went bankrupt.

The term "cash flow" is used interchangeably with other phrases, like "EBITDA," "owner's discretionary earnings" and "owner profit" to mean the amount of money available for personal use by the owner of a small or mid-sized business after all expenses are subtracted from the company's total revenues. It's an expression that is rather imprecise as it refers to a figure that can be calculated various ways.



The term often is heard or read in connection with the examination of a business for sale. The owner/seller or a business intermediary attempting to find a buyer might use the term in connection with a specific amount or as an expression with its general meaning, but without quantifying it.



Usage With A Specific Amount



If a buyer is told the cash flow of a business was $86,500 last year-- an example of the expression of the term in connection with a specific amount - the underlying understanding is that there is a formula by which this figure is calculated. But it's not like EBITDA (earnings before interest, taxes, depreciation and amortization), which describes the amount available for owner use and is determined in a commonly accepted manner. The term 'cash flow' could be calculated several ways. For instance, there are different depreciation and amortization schedules that could be used. And what some owners might consider personal expenses, others will charge against the business. When discussing a specific amount of cash flow, it's important to know exactly how that figure was determined.



Usage As A General Expression



The mention that a business has positive (or negative) cash flow is a general description about its success, without quantifying it. Business intermediaries, as well as buyers and sellers often use the expression 'cash flow' when referring to a factor in the company's performance. In that way, the term is used much like expressions such as "revenues" "gross" and "profitable" to refer to characteristics of the business, but without specifying actual figures.



While the term is useful in explaining the overall characteristics of a business, anyone using or hearing the words "cash flow" needs to understand that it's not necessarily useful if not quantified with a specific amount along with an explanation of precisely what calculation was used to arrive at that amount.


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