UNDERSTANDING YOUR CASH FLOW

Have you ever heard the expression "cash is king"? Well the  statement of cash flow is the crown. Your statement of cash flow shows how a company spends its money (cash outflows) and from where a company receives its money (cash inflows). The cash flow statement includes all cash inflows a company receives from its ongoing operations and external investment sources, as well as all cash outflows that pay for business activities and investments during a given quarter.  Let's first understand what goes into a cash flow analysis. 

The two main measures to assess a company’s debt capacity are its balance sheet and cash flow measures. By analyzing key metrics from the balance sheet and cash flow statements, investment bankers determine the amount of sustainable debt a company can handle in an M&A transaction.

Debt to Equity ratio provides lenders with a high-level overview of a company’s capital structure.

Another set of measures investment bankers use to assess debt capacity is cash flow metrics. These metrics include total debt to EBITDA, which can be broken down further to senior debt-to-EBITDA, cash interest coverage, and EBITDA-Capital Expenditures interest coverage.

The Debt-to-EBITDA measure is the most common cash flow metric to evaluate debt capacity. This ratio exhibits a company’s ability to pay off its incurred debt and provides investment bankers with information on the amount of time required to clear all debt, ignoring interest, taxes, depreciation, and amortization.

The cash interest coverage measure depicts how many times the cash flow generated from business operations can service the interest expense on the debt.

By taking the EBITDA, deducting capital expenditures, and examining how many times this metric can cover the interest expense, investment bankers can assess a company’s debt capacity.

The fixed-charge coverage ratio is equal to a company’s EBITDA – CapEx – cash taxes – distributions

Why You Care?

The reason you the business owner wants to understand your cash flow is because most lenders based a lending decision on the cash flow of the business as it key to successful business planning and forecasting of revenue. When you understand your cash flow you can connect this to your understanding of your debt capacity, which then leads to your revenue analysis. All these combined determine your profitability and risk ratio to a lender, insurer, even major clients may want to if you are financial stable to complete  project.