Canadian Business Loans

Is Your Cash Flow really free? And how Free is It!




Canadian business owners and financial managers might not be familiar with the term free cash flow. When owners discuss business loans with their bankers and other lenders they often focus on the ‘profits ‘their firm is generating. More sophisticated owners and financial managers realize that profits in fact have not a lot to do with cash flow. Furthermore, those owners that understand the concept of ‘cash flow ‘are unfamiliar with our term, we note as ‘free cash flow ‘.

When the business owner takes his financials into the bank he is often proud of course to discuss the ‘profit ‘that the company has generated. The banker or other instuitional lender is probably turning over those pages in the financial statement and looking at the cash flow. Cash flow will of course repay any loans that are made, not profit, which is a term from the income statement of course. Profit and cash are never really equal or identical amounts on the financial statement.

We should also assess the quality of the profits and earnings – as they may be distorted in a number of different ways. Many companies prepay things like advertising, insurance, development etc and hope they will of course bring in future profits . They may, but then again they may not. Inventory is bought and paid for, and will hopefully be sold, but in some cases inventory will be rendered obsolete.
Another angle for our profit analysis, as it relates to our concept of cash flow discussion is the fixed assets on our balance sheet may or may not be true resemblance of their actual value or replacement cost.

All of this brings us to the key issue of our concept of ‘free cash flow ‘, and that is the issue of capital spending. Because it usually is a major capital outlay for any firm, and the fact that assets will bring income over a much longer period of time, it deserves a good amount of focus. What we are saying is that depending on your firms capital needs they will have potentially volatile effects on your cash flow. When your firm may be having a tougher year and liquidity is not optimal then it will be very challenging to make investments out of cash into new assets for the business. Therefore business owners, for cash flow purposes, should probably be reviewing on an ongoing basis their maintainance needs for their assets, and their replacement needs.

How can business owners estimate the level of capital expenditures and cash outlay? One great method of doing this is to monitor your cost of goods sold and benchmark it against our capital expenditures. They should probably be growing at the same rate – that’s a valuable analysis tool for your business and cash flow planning.

So lets come back to our definition and concept of ‘free cash flow ‘. Free Cash flow is calculated by taking your firms profits, adding in depreciation, and then subtracting your capital expenditures. As complicated as that might seem to non- financially oriented business owners it is simply saying that your firm is earning a profit, you are in a position to replace assets, and the amount left, your FREE CASH FLOW, still allows you to take on additional debt, declare a management dividend or bonus, etc .

Let’s recap – we are encouraging business owners to differentiate between ‘profit’ and cash flow. Once they have focused on cash flow (profit + deprecation) they should analyze that number in the context of additional assets they have to purchase to grow the business successfully. The amount of cash leftover after those asset purchases is a key financial metric for your banker, and it should be for yourself also , because, Cash is king!



Stan Prokop - founder of 7 Park Avenue Financial –

http://www.7parkavenuefinancial.com

Originating business financing for Canadian companies , specializing in working capital, cash flow, asset based financing . In business 10 years - has completed in excess of 80 Million $$ of financing for Canadian corporations . Core competancies include receivables financing, asset based lending, working capital, equipment finance, franchise finance and tax credit financing.





7 Park Avenue Financial
South Sheridan Executive Centre
2910 South Sheridan Way
Suite 301
Oakville, Ontario
L6J 7J8

Phone = 905 829 2653
Fax = 905 829 2653

Email = sprokop@7parkavenuefinancial.com