Numbers talk, Bullshit Walks
Honest and verifiable cash flow will greatly impact the sale price of a small business. Many buyers and business brokers go as far as stating that cash flow is everything. More than 70% of small business buyers are first time buyers coming out of corporate America. These buyers have one primary goal—to replace the income stream they lost coming out of their former jobs. For these buyers, the owner’s cash flow, secured through the small business acquisition, is their salvation and their main decision point on company value.
What is owners cash flow (CASH FLOW)? The simplest definition is: The amount of money a new owner would be able to take out of the business annually or the net benefit to the owner.
Through financial analysis, most items are fairly easy to quantify, such as net profit and owner’s salary. Some of the figures may be somewhat more difficult to discern. A professional business broker can assist in recasting the business’ income statement to determine CASH FLOW. A business broker’s job is not to create cash flow, but to be able to substantiate what is documented through company financials, tax returns, and a due diligence process. The following are the most common elements that comprise CASH FLOW.
Net Income before income taxes is the amount leftover after all expenses are deducted from revenue or the amount on which federal taxes are based. The net income can fluctuate from more than the normal increases and decreases in revenues and expenses. A good accountant will attempt to keep net income as low as possible for tax purposes; therefore, small net income does not necessarily reflect an unprofitable business. For example, a business owner might prepay expenses toward the end of a year in order to push tax liabilities to the following year if his net income is projected to be too high.
The amount of owner salary is normally a large component. Similar to net income, the amount of owner’s salary may fluctuate for tax purpose. When a business owner receives a salary, he has to pay taxes as an employer and employee; therefore, many times business owners elect to be paid a smaller salary and pay themselves through owner perks or net income.
Depreciation and amortization is a component of CASH FLOW. Both are non-cash expenses used to reduce taxes. Depreciation decreases taxable income but does not reduce cash. Lending institutions include depreciation and amortization in their cash flow calculations.
Interest is a component of CASH FLOW since it directly relates to the amount of funding of a particular owner rather than the business. A new owner might have more capital and therefore may not need financing, reducing interest expenses to zero. Interest can be attributable to bank loans, personal loans, equipment leases or any other debt instrument. Interest may go away after the sale.
One-time or non-recurring expenses can be considered components of CASH FLOW. In the most recently completed corporate tax year, determine whether an expense was non-recurring or extraordinary. The amount identified can be added to CASH FLOW. Extraordinary litigation expense is a good example unless litigation is an annual occurrence. Even uncollectible accounts receivable that are above the norm can most often be included.
One of the benefits of owning a small business is the ability to have a business pay for certain personal expenses. Owner perks are expenses that are personal to the owner; therefore none of these costs would be transferred to the new owner. If you have a paper trail of the owner perks, a buyer may then consider them in his analysis of sale price.
The most common owner perks that are acceptable by a prospective buyer are:
• Car payment—spouse and children’s car payment
• Car insurance—spouse and children’s car insurance
• Health insurance—spouse and children’s health insurance
• Life insurance—spouse’s life insurance
• 401(k) contribution
• Charitable contributions
• IRA contributions
• Meals and entertainment
• Travel and entertainment
Below is an example of a calculation of CASH FLOW:
Net income $100,000
Owner salary $80,000
Owner travel (personal) $5,000
Owner auto (personal) $6,000
Owner health insurance $7,000
Owners Cash Flow $268,000
If you are looking to sell your business, contact Peterson Acquisitions for a free consultation.