Importance Of Cash Flow | The Firm Exchange Blog

Importance of Cash Flow

Focus on Cash Flow Strengths to Maximize Sales Price

Post written by Firm Exchange on March 29, 2018

To get the best result from your sales process, let’s take a look at the importance of cash flow.  It is critical to showcase your business’ strong suits, particularly the strength and stability of discretionary cash flow.  Buyers will likely focus their due diligence on cash flow from the last two to three years.  From there, most buyers will then estimate future cash flows they can expect from the business.

In particular, buyers generally focus on what is called discretionary cash flow—the cash flow that the business owner has control over.  This is even more important for buyers who plan to take out loans to purchase the business.  Loans generally require monthly payments, which makes regular cash flow all the more attractive.

Understanding the importance of cash flow and emphasizing the strengths of your business are both major drivers for maximizing how much a buyer is willing to pay.  In preparing materials to share with potential buyers, look to highlight these strengths across the following topics.  These are each key areas buyers will investigate as they look to understand your business’ cash flow.

The Importance of Cash Flow Coming In

Revenue Growth

Consider your business’ recent history.  What have been the key drivers of sales growth over the last few years?  What will be the key events in the next few years that lead to future growth?  Buyers are looking for sellers who can clearly explain what has worked in the past and articulate a plan for the future.  Doing so will help you maximize your sales price by showing the business’ long-term value to buyers.

Revenue Diversity

Diversity of sales is a key indicator of future stability.  If an unexpected loss of key customers or products occurs, businesses with more than one source of revenue are less likely to suffer large drops in revenue and cash flow. Some areas of diversity to highlight could include:

  • Number of customers and sales per customer
  • Number of key salespeople and sales per employee
  • Sales by product or service
  • Sales by location

The better you are able to dispel fears of “what could go wrong” and ensure the buyer’s confidence in the business’ ability to grow after the sale, the more the buyer will be willing to pay.  If revenue for your business is concentrated in one area, all is not lost.  However, it will be important to show the stability of the sales and why you don’t expect that to change.

The more you are able to dispel fears of “what could go wrong” and ensure the buyer’s confidence in the business’s ability to grow after the sale, the more a buyer will be willing to pay.

The Importance of Cash Flow Going Out

Expense Growth and Margin Trends

Buyers will want to understand your business’ profit and cash flow margins.  These metrics show what percent of each dollar coming in translates to net profits and cash in the owner’s pocket.  The better your business shows growth in cash flow, the more a buyer will be willing to pay for your business. If the business’ margins have been declining, make sure to know why.  When expenses are on the rise, be prepared to explain why and what can be done to offset that.  Conversely, if margins have been increasing, look for ways a new owner can continue that trend.  As always, be as detailed and specific as possible.

Capital Expenditures

Capital expenditures (CapEx), or cash spent on physical assets the business uses to operate, are a key cash outflow for many businesses.  It is important to highlight these items to buyers along with depreciation schedules and current estimated values so buyers can formulate a forecast of future cash needs for the business.  As a rule, businesses with lower and/or more predictable CapEx requirements are worth more.  This is because there is a lower chance of large, unexpected cash outflows in the future.  On the other hand, a buyer will likely offer less money if there are any large, non-recurring CapEx outlays in the near future.

CapEx expenses are a key driver of the importance of cash flow
Capital expenditures (CapEx) can include things like appliances in a kitchen

 

Inventory Turnover and Working Capital Needs

Buyers will also want to understand how cash flow looks over the course of the year, in addition to the total amount.  If cash flows are not even throughout the year, help buyers understand the source of this “lumpiness.”  Similarly, if your business requires a lot of inventory or working capital, be prepared to discuss inventory turnover and the timing of receivables and payables.

Other Things that can Impact Cash Flow

Competitive Landscape

Are you the only game in town or do customers have a lot of options when it comes to the product or service you offer? If you do have a number of competitors, what sets you apart? How do you reach out to potential customers, and how do you retain your current clientele? Buyers will want to know that your customers aren’t going to disappear once the business is sold.  Prepare to explain the reasons customers keep coming back. Customer reviews, awards, rankings, etc. can be helpful in assuring the buyer that the business will succeed for years to come.

Patents, Trademarks and Other Intellectual Property

Do you have any patents, trademarks, or other intellectual property that protects your products or services? If so, make sure to highlight these to potential buyers. If you have anything you think might benefit from intellectual property protection, consider speaking to an expert.  You may want to assess the potential costs and benefits of legal protection before starting the sale process. A strong and well-known brand, particularly a legally protected one, is a valuable asset.

Management and Employee Retention

Many businesses are only as good as their employees.  It will be critical to demonstrate to potential buyers that key management personnel and employees will remain with the business after a change in ownership. Be prepared to answer questions about your employees, such as:

  • How long have key employees been with the company?
  • Are key employees subject to employment agreements?
  • If you are owner and manager, should the buyer be prepared to manage the business as well or is there an employee ready to take on a management role?
  • Do employees know that you are looking to sell the business?

Some buyers may request access to key employees as part of their due diligence process.  Have a plan in place to inform employees and address any of their concerns.

Understand the Importance of Cash Flow to Achieve a Better Sale Price

Finding the right buyer who is willing to pay a premium value for your business isn’t easy.   By focusing on your business’s cash flow strengths, you’ll be well on your way to achieving a better sale price for your business.

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For a more detailed look at the specifics of cash flow, we recommend this excellent article on Investopedia.com.

DISCLAIMER: The information contained in this article is for informational and discussion purposes only, and should not be relied upon without seeking your own professional advice. The Firm Exchange, LLC is not a law firm, accounting firm or professional services firm, and accordingly it disclaims any liability for any reliance on the contents of this article. As each situation is unique, you are encouraged to discuss your specific situation with a qualified attorney, accountant and/or other relevant professional services provider.