On certain occasions, economic indicators are used to measure the benefits a company generates, as if these indicators provided a comprehensive view of the company’s "health," even though this is not always the case.
One of the most widely used indicators is EBITDA. While it is easy to calculate and compare, it represents only part of the picture and should be complemented by more in-depth analysis to avoid falling into the "trap of illusion."
It remains a useful concept when comparing a company’s profitability against the industry average or similar businesses, or when analysing its evolution over recent years.
Although quickly and simply determining whether a business is profitable can be helpful, the risk often lies in "confusing" its result with an estimate of the company’s cash flows.
It can be said that EBITDA merely shows the outward appearance of a company, that is, its "musculature," without necessarily considering whether it has a well-functioning interior capable of continuing to generate the energy required to sustain an adequate level of "breathing" over time.
For this reason, its use often leads to the "illusion" of treating a company’s profits as though they were the cash generated, applying an economic concept in an attempt to explain something that is inherently financial.
The importance of cash flowThe reality is that cash flow is the true indicator of a company's in-depth financial health, as it allows us to understand the state of its "vital signs." A good EBITDA level could also, in some cases, "hide" certain issues in business management.
The reality is that cash flow is the true indicator of a company’s in-depth financial health, as it allows us to assess the state of its ‘vital signs’. A strong EBITDA level could equally ‘conceal’ certain issues in business management.
This illusion becomes more pronounced as EBITDA levels rise, potentially creating a sense of success. However, this does not necessarily mean that the company’s ‘oxygen levels’ are optimal at the same time.
Therefore, nothing is more critical than the cash flow generated, as it is essential for the proper functioning of the company’s other ‘organs’, ensuring ‘good health’. This enables the company to meet its obligations and engage in more ‘demanding’ activities in the future.
This is where cloud-based treasury management solutions make a difference. With Embat, financial teams can monitor cash flow in real time, forecast liquidity needs, and automate processes such as bank reconciliation and payment planning. This leads to an integrated and dynamic perspective, enabling risk anticipation and the optimisation of financial management.
Without a healthy cash flow, any company - regardless of its size, sector or apparent successes, faces important risks in the future, where the critical aspect is always maintaining a proper balance between ‘inhalation’ (cash inflows) and ‘exhalation’ (fund outflows), thereby regulating its levels of ‘oxygen’.
We should not forget that the businesses, like individuals, go through different stages in their lifecycle, experiencing periods of greater abundance and resource scarcity. In such times, a robust ‘emergency fund’ allows a crisis to be managed differently, provided the necessary ‘reserves’ are available.
A similar phenomenon occurs during periods of business growth. If the necessary financing (whether internal or external) is not available, this lack of capacity can result in ‘poor breathing’, hindering the ability to meet established objectives and triggering a crisis - one that is often extremely difficult to overcome without incurring significant damage.
For this reason, rather than succumbing to the ‘illusion of EBITDA’, the priority should be building a solid structure for generating cash flows. This ensures liquidity and supports the company’s long-term growth. While this is no easy task, it provides the certainty of always understanding the company’s true state of health. After all, one thing we can be absolutely certain of is that:
Cash is King!!
