Cuba just experienced a nationwide electrical blackout, this after numerous partial blackouts, closing of schools and other “non-essential” buildings, and doing other things to preserve capacity.
So, what happened? They fell way behind on their capital expenditures to maintain their grid. Lessons for small business from this include:
- Allow for the fact you may have tangible assets you need to maintain, replace or add to what you have. Things don’t last forever. My best example is if a company has 21 trucks, a truck lasts seven years, then expect to replace three trucks every year, on average.
- What capital expenditures are anticipated? Using the truck example, if the business secures a new territory and it needs three more trucks, that must be factored into projections.
- Depreciation may technically be a non-cash expense (book definition), but it’s real cash out when you pay cash, make loan payments, or lease (leases now need to be capitalized on the balance sheet).
I see and hear a lot of baloney about how depreciation can be added-back to profit. It only makes sense if you then subtract anticipated capital expenditures. This protects the business seller who just made a once in 10-years purchase and the buyer who may have annual cap ex.
“Too many investors focus on earnings before interest, taxes, depreciation and amortization. That makes sense only if you think capital expenditures are funded by the tooth fairy.” Warren Buffett
“Among those who talk about EBITDA (earnings before interest, taxes, depreciation and amortization) and those who don’t, there are more frauds among those who do. Either they’re trying to con you, or they’re conning themselves.” Warren Buffett