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Every small business has a limiting factor. It could be leads, cash flow, capacity, almost anything. The Small Business Doctor diagnoses and develops a treatment plan for your bottleneck.
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EBITDA is often treated as a proxy for operating cash flow by finance professionals. While EBITDA is an important finance metric, it is not the same things as operating cash flow. For small businesses, the difference between them is especially important.
Here’s an example. Windmill Bakery had a great year. Their income statement shows the following:
| Net Income | $1,800,000 |
| Depreciation & Amortization | $1,500,000 |
| Interest Expense | $300,000 |
| Income Tax Expense | $400,000 |
| EBITDA Reconciliation | Amount |
|---|---|
| Net Income | $1,800,000 |
| Add: Interest Expense | $300,000 |
| Add: Income Tax Expense | $400,000 |
| Add: Depreciation & Amortization | $1,500,000 |
| Equals: EBITDA | $4,000,000 |
Wow! That’s great. Windmill Bakery earned a healthy $4M of EBITDA last year. But that’s an incomplete picture. Their cash flow statement shows the following:
| Cash flows from operating activities | Amount |
|---|---|
| Net Income | $1,800,000 |
| Add: Depreciation & Amortization | $1,500,000 |
| Less: Increase in Accounts Receivable | – $1,000,000 |
| Less: Increase in Inventory | – $800,000 |
| Less: Decrease in Accounts Payable | – $600,000 |
| Equals: Operating Cash Flow | $900,000 |
Increases to inventory and accounts receivables use up cash as does paying down more of your accounts payable. The result is that while Windmill Bakery has an EBITDA of $4 million, it has operating cash flow of only $900,000. That’s less than a quarter.
Working capital movements don’t affect EBITDA, but they sure do affect cash flow. Since cash flow problems are the biggest risk to a small business, it’s crucial that small business owners get professional financial help. EBITDA assumes there are no meaningful delays in converting accounting profits into cash and no meaningful inventory fluctuations. Real world small businesses never operate that way.
What are some practical things Windmill Bakery could have done to increase cash flow?
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Over the years, I have happily and confidentially advised a wide range of clients from a plumber near Pittsburgh to a robotics startup to a multi-state pediatrics practice. I am always your primary point of contact and hold myself accountable for your success.
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Hi there! I'm Matt. I'm a Christian, husband and father of four. I'm a graduate of Calvin, Harvard, Cardiff and Johns Hopkins Universities. I have a PhD in Economics, an MBA in Finance and an MS in Data Analytics. I'm a numbers guy who can communicate well!
I began this service to work directly with the small and mid-sized business owners who grow our great country's economy. Since 1999, I've worked with owners across industries from high tech IT and robotics to small farmers and artists. I've also helped and advised nonprofits from churches to civic organizations.
I also served as a Finance Staff Officer and eventually as the National Division Chief for Measurement Research within the US Coast Guard. The research and methods I created there continue to guide strategic decisions to this day.
I enjoy being active outdoors, especially in wild lands. Hiking, biking and fly fishing are some of my favorite pastimes.
I also love dogs! I'm an AKC obedience evaluator, and I train service and therapy dogs.
Operating Expenses Disguised as Inventory
Companies need to keep some amount of inventory. When I go to a home repair supplier, I expect them to have the copper pipe I need in stock. When I go to my local bakery, I expect them to have the macarons I crave in stock. When I go to my local grocer, I expect […]
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Transaction Costs in the American Economy from 1870 to 1970
What Are Transaction Costs? Transaction costs are often overlooked in economics and textbook finance. In real life economics, however, they play a very significant role. In corporate finance, you can see many of a company’s transaction costs located in the selling and administrative categories within the Selling, General and Administrative (SG&A) section of their Income […]
During the Great Depression, British economist Ronald Coase wrote a famous essay on the nature of the firm or company. As with America at the time, many free-market economies were also enduring a severe and difficult economic depression. The Soviet Union, however, was growing to become a significant industrial economy. This led to a debate […]
Transaction Costs and SG&A Expenses
Selling, General or Administrative Expenses One way to see how economic transaction costs are internalized within a company is in the SG&A Expense lines of a company’s income statement. All of the selling and administrative expenses are internalized transaction costs, and so is the insurance expense within the general expenses category. This is not the […]
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Statement of Comprehensive Income
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