You already know that your business turnover and profits play a big role in how much your business is worth.
Do you also know the role cash flow plays in your valuation?
Cash vs. Profits
Cash flow is different from profits in that it measures the cash coming in and out of your business rather than an accounting “magic” of your profit and loss. For example, if you charge $10,000 upfront for a service that takes you three months to deliver, you will be recognising only $3,333 in revenue for 3 months.
But since you charged upfront, you get all $10,000 of cash on the day your customer decides to buy (go you!). This positive cash flow cycle improves your business valuation because when it comes the time to sell your business, the buyer will have to write two cheques: one to you, the owner, and a second to your company to fund its working capital – the cash your company needs to fund its immediate obligations like payroll, rent, etc.
The trick is that both cheques are drawn from the same bank account. So if you are receiving cash in advance, the requirement for working capital is reduced, which means more for you.
Unfortunately, the inverse is also true.
If your business is a cash suck, an acquirer is going to calculate that they need to inject on closing day, which depletes their resources and results in less for you.
How To Improve Your Cash Flow
There are many ways to improve your cash flow – and therefore, the value of your business. One often overlooked tactic is to spend less on the machines your business needs to operate.
In the restaurant business, for example, there is an often repeated truism that it takes three bankruptcies at a single location before any restaurant can make money. The first owner of the restaurant walks in and – with all of the typical optimism of a new entrepreneur – pays cash for a brand new commercial kitchen complete with fancy stove, commercial grade walk-in coolers, etc., as well as all new dishware, pots and pans, thus depleting their cash reserves before opening night. Within a year, the restaurant owner runs out of cash and declares bankruptcy.
Then along comes a second entrepreneur who decides to set up their restaurant at the same location and buys all of the shiny new equipment from owner number one’s creditors for 70 cents on the dollar, figuring they made a wonderful deal. But the outlay of cash is still too great and they too are out of business within a year.
It’s not until the third owner comes along that the location actually survives. They save cash by buying all of the equipment off the second owner for 10 cents on the dollar.
The moral of the story is: find a way to reduce the cash you spend on equipment, however you can. Can you buy your gear used on sites like eBay? Can you share a very expensive piece of machinery with another non-competitive business? Can you rent instead of buying?
Profits are an important factor in your business value but so too is the cash your company generates. We call this phenomenon, The Valuation Seesaw and it is one of the eight key drivers of the value of your business.
Owner of PCR Accounting & Advisory, Peter Marmara-Stewart is a top-tier accountant and financial advisor dedicated to helping clients reach their business goals and achieve financial freedom. Peter is highly regarded for his client-focused approach and entrepreneurial spirit, catering to a diverse range of professionals across a wide scope of industries all across the country. Peter’s expertise can help you plan effectively, set goals, maximise profits and protect your assets. Get in touch today on (03) 9847 7516.