Value Drivers: Clean and Accurate Financials (Part II)
Current Financial position and historical records are the major factors in putting a value on a business. Last week the focus came down to trust issues around the financials. This week we’ll focus on the numbers.
Definition of Cash Flow: owner salary, net profit, depreciation, interest expense, and discretionary expenses not necessary for continuing operations
As mentioned in last week’s blog, the typical business advisor (accountant, financial planner, attorney, banker, business coach, etc.) needs to understand the existing situation and historical information to unlock some mysteries in the business. What are the trends, opportunities, threats? Solid financial information should lead to solid advice.
When selling a business, the marketplace puts a value on the cash flow of the business. Have the cash flows been steady, increasing, or decreasing? Are the cash flows readily apparent in the financial statements? Is the cash flow expected to continue or are there major changes expected? A buyer needs to understand the cash flow in order to make a good offer on a business. That offer takes the following into consideration:
1. Return on the buyer’s initial investment (paying the new owner’s salary),
2. Cash to pay off debt for the acquisition, and
3. Retaining cash in the business to support operations.
A business that shows a cash flow of $100,000 may be able to achieve a market value of 2 or 3 times that amount. Let’s say the value is $300,000 (3x $100,000). Last week I used an example of someone sending a family of 15 on a European vacation. Let’s say that the tax deduction used for that vacation was $25,000, and the tax savings was approximately $7,500. It feels good to save $7,500 on taxes; however, the value of the business went down considerably more than that. A $25,000 expense translates into lost business value of 3 x $25,000, or $75,000!
Sure, there is negotiation, and this is just a simple situation that should be easy to explain to the buyer and the bank. It does illustrate a point, however, that some simple tax dodges to save a few bucks will certainly make a much larger reduction in business value.
Talk to one of our Apex Business Advisors to help you plan and improve the value of your business before it is time to sell.
