What exactly does the term “Cash Flow” mean?
GREAT question!! Cash flow is probably the most frequently misused accounting term I can think of.
Cash flow is NOT profit.
First understand that “cash flow” as a term for valuations is far more applicable in large business transactions, and not smaller ones where the buyer will be taking over from the former owner.
In its purest form cash flow means: “the amount of cash that the business had at the beginning of a period, what it had at the end of a period, and what happened to the difference.”
You’re probably going to come across this term during your search to buy a business in numerous locations such as business for sale websites, financial statements, broker listings, etc. It is imperative that you get a breakdown of what is included in this so called “cash flow” number. More than likely, it is not the correct terminology for the figure you will review. What is often referred to as cash flow in small businesses for sale is actually the Seller’s Discretionary Cash Flow, Adjusted Income/Profit or Owner Benefit figure. This is typically the total of net income, owner salary, perks, depreciation, interest, and non recurring expenses. (By the way it should also include a provision for capital expenditure allocation but that’s a whole different discussion).