You have probably heard a banker ask "Does your business cash flow?"
Many small business owners may not know how their company's cash flow is calculated. The following illustrates the generally recognized concept of cash flow. The general formula is ... Net income plus depreciation less your company's principal payments due in the next 12 months.
For example, let's assume the following ...
Your company made $200,000 profit last year.
It also had $100,000 of depreciation in the same year.
Your company will pay $12,000 per month on various loans, $11,000 per month of which is principal.
The calculation is…
Net income + $200,000
Depreciation + $100,000
Principal payment - $132,000 ($11,000 principal x 12 months)
Net Cash Flow = $168,000 (1+2-3 = 4)
What does this mean? Your company generates $300,000 to service $132,000 of debt payments. This leaves free cash flow of $168,000. This equates to cash flow coverage of 1.27%. Cash flow coverage in excess of 1.1% is good.
As you can see, this company cash flows very well. Assuming the net income does not contain slow paying receivables or obsolete inventory, the company should be operating with sufficient cash. Take your last year's financial statement and plug in your applicable numbers.