A symptom, not a disease
We regularly receive inquiries from business owners and entrepreneurs regarding cash flow problems, almost all of which are focused on finding financing. These business owners come to us after being refused further credit lines, discounts, etc., by financial institutions, seeking our help in securing additional funding.
But cash flow problems are a symptom, like a fever, an indicator that something isn't working properly. We can lower a fever with cold baths, but we can't get rid of it without addressing the underlying infection. Similarly, we can alleviate cash flow problems with bank loans, but we won't eliminate them if we don't resolve the root cause.
A good way to identify the cause of that tension is to analyze the Cash Flow , a financial statement that we have already discussed on this blog.
We have prepared a very simple Cash Flow to analyze different scenarios and thus understand how this tool works, but first we need to clarify some concepts:
EBITDA: This is the operating profit (or loss) before deducting amortization. To calculate it, we subtract purchases, personnel expenses, and all other expenses strictly necessary to carry out the business from sales. We do not subtract amortization, financial expenses, or other extraordinary expenses or income. It could be understood as the money the company would have generated from its operations during the year if everything had been collected or paid in cash.
Depreciation: These are the expenses we allocate in the year for the use of machinery, facilities and other elements that we need to work, and which have a useful life of more than one year, so their cost is spread over the number of years of their life.
Capex, or Fixed Assets, or non-current assets, is the set of assets necessary to work with a useful life of more than one year (machinery, furniture, …), almost all of them are depreciated.
Current assets: are the set of goods or rights that will be converted into money during the year (stock, credits to customers, etc.) less the obligations that we acquire with suppliers and creditors to carry out the activity (which we must pay).
Financial liabilities: This is the debt we have with banks and other financiers; credit is essential to carry out the activity.
And this is our small cash flow model, in our first, fictitious company. There is no cash flow pressure, and the cash balance at the end of the year is higher than at the beginning:
We started the year with €20 in cash. Sales and purchases for the year resulted in an EBITDA of €60. I need to allocate €15 to working capital because my sales have increased my credit to customers by €30. I've also paid €15 for the purchase of production machinery, paid the interest on my bank loans, and repaid €10 of the principal on those loans. In total, all my transactions have generated a surplus of €17, bringing my final cash balance to €37. We haven't experienced any cash flow problems this year.
But what if the result of the activity were different? The next company doesn't add cash with its activity, but rather subtracts it; the difference with the previous one is solely the EBITDA. So, either it sells less, or it operates with a smaller profit margin on its sales, or its staff is more expensive, or it pays higher rent for its premises. To understand why its result is lower, we must analyze its Profit and Loss Statement. If we don't correct it, we will have cash flow problems next year.
In upcoming articles, we'll analyze different cash flow examples so that we can ultimately identify the root causes of our problems. And if you'd like us to create and analyze your own cash flow statement, you can contact our finance department directly.
Do you have any questions about this topic?
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A graduate in Economics from the University of Barcelona, he is also a Certified Actuary, Real Estate Agent, and Insurance Broker.
He furthered his training with courses in taxation, business valuation, and credit management offered by the College of Economists of Catalonia and the Center for Financial Studies (CEF).
In 2000, he became the managing partner of the firm, and since 2011, he has also been responsible for the Finance Department.
For five years, while already a member of the management team at Àmbit Assessor, he also held the positions of Deputy General Manager and Finance Director at Alco Grupo Empresarial.
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