This article was first published on the 20th of August 2018.
Manage your business cashflow in a healthy way and it will support the value of your business sale. Ignore it and it will cost you money. Let me explain with a trip to a more simple time when cash was king.
Imagine Baldrick turning up to market with coins in his pocket and needing to feed Blackadder. He has no option to overspend. His budget is absolute.
So it is with business buyers. They may have access to lending lines, cash and credit but they will also set themselves an absolute budget. The metaphorical coins in their ‘buy a business’ purse.
And what has this got to do with cashflow? Back to our market.
Now imagine Baldrick needs to buy food, but also coal for a fire etc. These additional overheads have to be accounted for. But the total budget remains the same. The consequence is less to spend on food because the budget is split.
Back to our business buyer. Their budget will take into account the working capital necessary to make it through the first month(s) of ownership. If you manage your cashflow well and reduce your working capital requirement, the buyer needn’t hold as much back and can pay you a higher sale price.
Here, John Warrillow, founder of the Value Builder System explains it in his own words;
What do we mean by cashflow?
Cashflow is the money that flows in and out of your business. It can be positive (cash generating) or negative (sucking cash out) and it affects every aspect of business.
Closely linked to working capital the things you do to improve your cash flow management will affect your working capital and this is the figure most often spoken about in business sales.
Let’s break it down into the main attributes of cashflow and how you can positively manage them.
When you raise an invoice for the work you do, how long does it take for you to get paid? The goal is to be paid as quickly as possible because that brings cash into the business.
If you’re not being paid immediately, why not?
Do you have 30, 60, 90 day payment terms? Why?
Why are you allowing your customers to benefit from the cash that is rightfully yours? That money should be with you, allowing you to re-invest in marketing, new stock, delivering new projects.
Often, when businesses start up, they look around to see what the ‘norm’ is. We have met many smaller businesses grating long payment terms to customers because that is the only example they saw when they started. If you are going to offer generous payment terms, there must be a sound business reason for you to have implemented them. Circumstance is not an excuse.
Hypocritically, this is the complete opposite of invoicing. When you owe money elsewhere for goods or services, you should take as long as you are offered to pay.
If someone is offering 60 days payment, take it. The cash works for you in those 60 days.
Don’t be a late payer. We are not talking about defaulting on agreements and gaining a bad reputation, we are simply taking advantage of what is offered.
Cash v Profit
You may have a profitable business with no cash in it. Profit is an accounting term, cash is what you have in the bank. You might have sent out your month end invoices, but if those people don’t pay, you don’t have the cash.
Don’t confuse profits for cash and collect that cash into a liquid state as quickly as you can.
Often the businesses we see who do not have a handle on their cash flow are the same ones which abdicate all financial responsibility to their accountants.
You can’t run a successful business at arms length by abdicating responsibility altogether. Understand the cash in’s and out’s of your business and forecast them ahead.
Technology makes this easy for us with Quickbooks, Xero, Sage and any number of other platforms. Know what your business break even point is and use this knowledge to improve your cash flow.
If you operate in the wedding sector, you will make most of your profit in the summer months. Same goes for holiday destinations.
If you are a retail business or in the restaurant trade, you will make most of your profits in the Christmas season.
Be aware of the seasonality of your own business. When sales are at their highest and at their lowest. You are going to have to hold some cash over for those leaner times.
Reserves & instalments
So building up cash reserves will help support your business through leaner times. Extending this practice to payment by instalments can also help with cashflow.
For ongoing utilities and rent, pay monthly, or syphon cash off into a separate bank account on a monthly basis to cover these.
Same principle goes for your VAT and Corporation Tax. Put aside a percentage of sales income each week/month, so you have the inevitable tax bills covered.
Stock is a profit item, but not cash. Hold too much of it and you strip your business of the ready cash you need to pay suppliers.
Imagine you’re the new Kwik-Fit competitor. You replace tyres.
In order to do that you have to keep a stock of tyres in different sizes and from different manufacturers. If you don’t have the make and size a customer wants, they will go elsewhere.
So you naturally have to carry a fair bit of stock.
But, for every day each tyre sits on your stock shelf, it is not working for you. It is dead money until someone pays for you to fit it.
Are you a SLOB?
This leads to the question of a SLOB (SLow moving and OBsolete stock).
It might be that you said yes to a great price deal if you ordered ‘last seasons’ model.
It may be you purchased something you thought would sell, but simply didn’t.
It might even be that something which used to sell like hot cakes suddenly stopped (e.g. plastic straws).
However it got there, if you took a close look at your stock you might find SLOB items which take up space but are unlikely to sell again. They are dead money. In fact, they are probably costing you more to store them.
Half of the self storage industry has grown on the back of people being unable to divest themselves of ‘stuff’ they don’t ever use that clutters up their homes. So rather then sort through it, throw away the trash and give away to charity, they pay hire charges to store it.
Your SLOB stock will cost you in more storage racking, space, or simply time as staff navigate around it to get to what they need.
Advice for dealing with old stock
Don’t be sentimental. Don’t try to defend a purchasing decision past it being defensible. The primary aim is to get cash back into the business.
Sell it on Ebay or at vintage markets, sell it in bulk at a heavily discounted price, give it away to charity or sell it for scrap value.
Recouping some money rather than no money is a better position for your business. And that might mean you take a loss on what you paid.
Take it on the chin and learn from the situation for next time.
What are the differences between industries?
A business in the HR service sector is not going to hold any stock but may be able to improve their customer invoice collection times greatly.
A manufacturing company will hold a lot of stock, both in raw materials and finished goods. They may be able to explore ‘just in time‘ delivery for raw materials to minimise that stock value, although they may continue to hold finished goods.
In retail, seasonality is going to have a big effect on cash flow and stock, so end of season sales may well be an important factor in liquidating cash.
Every business sector will have its nuances which means every business buyer will be alert to knowing how well you handle them.
How does cash flow affect business valuations?
There are 2 things at work here.
1. practical cash management
1. Practical cash management
Right at the start of this article we set said a buyer only has a certain amount to spend on a business. We also touched on the working capital a business needs month by month and how money will be diverted away from your sale price to support those first month(s).
Let’s go back to our tyre sales.
Suppose we buy a tyre into stock at £40. Once fitted, we sell at £80, creating a 50% profit. Lovely. But that profit only liquidates when the fitting is done. In this example, the tyre sits in stock for 60 days before being fitted.
If that is representative of all stock, our business buyer is going to need to support the business financially for 60 days before they see cash coming back in. As owner, your sale offer will be lower.
So the things we can improve in the business to shorten that cash flow cycle are critical.
One improvement might be to lengthen the creditor terms of the tyres coming into stock. They may arrive on day 1, but you might negotiate 30 day payment terms. You hold onto your cash for longer reducing the 60 day cash cycle down to 30 days.
Another might be to implement just in time delivery, so the tyre only arrives in stock on the day the fitting is booked. Effectively, the cash paid out to the supplier and coming in from the fitting happens the same day.
As the buyer of your business, if you can see cash coming back into the business (cycling through it) every 10 days, the need for additional financial support reduces drastically. You are more likely to receive a higher sale price.
More subtle, but no less important. This one revolves around SLOB stock.
Stock is an asset, has a value on your balance sheet and is being bought as part of the business sale. A buyer will want to examine it.
On examination, if the buyer finds obsolete, damaged and slow moving items not typical of your business type, they will become suspicious.
They will become suspicious that you are trying to hide sub-standard stock in the sale. They will also query the quality of your management. Basically, “If this is the state you let your stock get into, what else are we likely to find hiding in this business?”
As business brokers, we can always find a deal structure that works for both parties, but it’s much harder to repair the broken confidence of a buyer.
As with many of our articles, the issues we cover are not only essential at the time of selling a business. The things we cover also make good business sense and drive success outside of the business sale period.
If you would like to talk to us further about cashflow management or working capital, please get in touch.