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During my college course on accounting cash flow was by far the most difficult to understand and I still find it difficult in light of the cable company example

During my college course on accounting cash flow was by far the most difficult to understand and I still find it difficult in light of the cable company example. As an owner you still want money to spend. How do you get that if not from the profits?

chrisco255 4y ago
Well in the cable example it was from capital investors. But also, since the business was pulling in cash flow it could use its present customer revenue to immediately reinvest in expanding the business. So on paper the business would show little to no profit, probably even negative in some years, while the business was actually growing at 30% a year. It's a riskier model for non-cash flow based businesses though, in my opinion. If you don't have a stable source of cash flow from something like a subscription model it's harder to count on revenue being consistent (unless you're dominating a particular market). Also can be risky if you only have one or a few clients providing the cash flow. If they pull out or go belly up, your business can be decimated with whatever overhead you added to provide for them.
wongarsu 4y ago
If you have growing cash flow, and can plausibly show that you will be making profit in the next 5 years, or even better that you could be making profit right now if you stopped reinvesting, you won't have a problem getting either investors or a bank loan.
gvb 4y ago
As an owner you still want money to spend. How do you get that if not from the profits? In the cable company example, from taxes (not paid) and accelerated depreciation (a big part of the taxes not paid). Money is fungible and cash is the ultimately fungible form of money. Tax money (not paid) is better than money taken as taxed profits. By running the business at a loss (from a profit/loss point of view), the cable company paid little or no taxes. You can take $100 in profit and pay $30 in taxes (net $70 in your pocket), or you can show $0 profit and roll that $130 into your business expecting $130 + growth in the future. Note that, with the cable company example, the cable company "was unprofitable" every year yet paid a compound return of 30% to its shareholders.
- wodenokoto 4y ago
  Sure. But if I roll all revenues into the business where are the money to pay my personal rent and groceries as the owner?
  - dmurray 4y ago
    You pay yourself a salary. That's the business investing revenue back into its employees. And yes, you'll pay income tax on that, but that may only be a small part of the value you've created. Or you sell some shares, or borrow against your equity. Perhaps you can roll it forward indefinitely and you're in a jurisdiction where your heirs get favorable tax treatment by inheriting the business.
  - biorach 4y ago
    You pay yourself a salary. The whole setup probably requires operating at a much larger scale than that of a sole trader or small family business.
  - deleted 4y ago
    [deleted]
evanpw 4y ago
I had the same question while reading. It's probably obvious to the startup crowd, which is why it wasn't made explicit, but I think the trick is this: a company which will never make a profit is (should be) worth zero, but a company that has the ability to make a profit in the future is valuable, even if current profits are zero. So rather than making a profit and paying it to yourself, it's better to make the company as valuable as possible to other people by reinvesting everything, and then sell stock or borrow against it for your own consumption. That definitely seems true for the most prominent outliers, but no idea whether it's actually true for the average or median owner / founder. I guess this why EBITDA is important: if you have positive EBITDA and stop growing the business, you can pay off your loans, finish depreciating your existing equipment, and with I=D=0 you have real profits.

chrisco255 4y ago

Well in the cable example it was from capital investors. But also, since the business was pulling in cash flow it could use its present customer revenue to immediately reinvest in expanding the business. So on paper the business would show little to no profit, probably even negative in some years, while the business was actually growing at 30% a year. It's a riskier model for non-cash flow based businesses though, in my opinion. If you don't have a stable source of cash flow from something like a subscription model it's harder to count on revenue being consistent (unless you're dominating a particular market). Also can be risky if you only have one or a few clients providing the cash flow. If they pull out or go belly up, your business can be decimated with whatever overhead you added to provide for them.

wongarsu 4y ago

If you have growing cash flow, and can plausibly show that you will be making profit in the next 5 years, or even better that you could be making profit right now if you stopped reinvesting, you won't have a problem getting either investors or a bank loan.

gvb 4y ago

As an owner you still want money to spend. How do you get that if not from the profits? In the cable company example, from taxes (not paid) and accelerated depreciation (a big part of the taxes not paid). Money is fungible and cash is the ultimately fungible form of money. Tax money (not paid) is better than money taken as taxed profits. By running the business at a loss (from a profit/loss point of view), the cable company paid little or no taxes. You can take $100 in profit and pay $30 in taxes (net $70 in your pocket), or you can show $0 profit and roll that $130 into your business expecting $130 + growth in the future. Note that, with the cable company example, the cable company "was unprofitable" every year yet paid a compound return of 30% to its shareholders.

wodenokoto 4y ago
Sure. But if I roll all revenues into the business where are the money to pay my personal rent and groceries as the owner?
- dmurray 4y ago
  You pay yourself a salary. That's the business investing revenue back into its employees. And yes, you'll pay income tax on that, but that may only be a small part of the value you've created. Or you sell some shares, or borrow against your equity. Perhaps you can roll it forward indefinitely and you're in a jurisdiction where your heirs get favorable tax treatment by inheriting the business.
- biorach 4y ago
  You pay yourself a salary. The whole setup probably requires operating at a much larger scale than that of a sole trader or small family business.
- deleted 4y ago
  [deleted]

evanpw 4y ago

I had the same question while reading. It's probably obvious to the startup crowd, which is why it wasn't made explicit, but I think the trick is this: a company which will never make a profit is (should be) worth zero, but a company that has the ability to make a profit in the future is valuable, even if current profits are zero. So rather than making a profit and paying it to yourself, it's better to make the company as valuable as possible to other people by reinvesting everything, and then sell stock or borrow against it for your own consumption. That definitely seems true for the most prominent outliers, but no idea whether it's actually true for the average or median owner / founder. I guess this why EBITDA is important: if you have positive EBITDA and stop growing the business, you can pay off your loans, finish depreciating your existing equipment, and with I=D=0 you have real profits.