The Importance of Cash Flow in your Business

Cash is King

cash flow is king when selling your businessCash is King, but  for the cash buyer, a slight modification to our saying is required: “Cash Flow is King.”

Our advisors often hear from business owners who say, “My friend sold her business for a six times multiple. Can I get the same type of multiple for MY business?” To understand why the answer is not a simple “yes” or “no,” we need to know what exactly is being multiplied.

Cash of course is our favorite thing to multiply. Investment bankers, sellers, and mergers and acquisition advisors of all kinds have a favorite phrase: “Cash is King.” Cash greatly reduces a seller’s risk in the transaction.

But for the cash buyer, a slight modification to our saying is required: “Cash Flow is King.” The buyer wants to know exactly how much cash the business is producing. In fact, few cash buyers are willing to part with their money unless they see a proven, and increasing, stream of cash flowing from the business.

The balance of our discussion is devoted to defining cash flow and examining its importance for third-party cash buyers who are interested in your business.

The Importance of Cash Flow

During the heyday of consolidation, companies used their own publicly-traded stock to aggressively pursue and acquire similar companies. This led to payments of multiples of earnings–sometimes of future earnings–that in our more sober climate seem stratospheric. Mergers and acquisitions activity is down as much as 80% from 1999. That frenetic period of consolidation is over.

Today’s buyers may still be anxious to acquire companies, but they are looking for “good” companies–those with increasing cash flow, solid growth potential, and strong fundamentals (including the management team and operating systems). These characteristics have always been important, but given the high rate of failure of recent mergers and acquisitions, cash flow has never been so important. Strong cash flow reduces a buyer’s risk, so for many sellers getting “six times multiple” of cash flow depends greatly on what exactly is meant by “cash flow.”

The Definition of Cash Flow

Another favorite, albeit less succinct, phrase of investment bankers is, “We can get you five or six times multiple of your cash flow as a purchase price for your business.” All you have to do is let THEM define “cash flow.” The devil in this case is in the definition. There are several definitions or measures of cash flow, each with significant differences. Typical measures of cash flow include:

EBIT: Earnings Before Interest and Taxes

EBITDA: Earnings Before Interest, Taxes, Depreciation and Amortization

True Cash Flow: The amount of pre-tax money distributed to owners via salary, bonus, company distributions such as S-distributions, and rental payments in excess of fair market rental value of equipment or buildings used in the business.

Each of these measures of cash flow can produce a different cash flow amount, and you can add to these measures the need to recast cash flow by using “add backs” such as excess rents, salary, or bonuses paid to the owners and their families.

This brings us back to our original questions. Can you get six times multiple when you sell your business? Sure. But, as we have explained, it depends greatly on how you define cash flow. To accurately determine which measurement is appropriate for your business, look first to the marketplace’s measurement for insider sellers. This “true cash flow” measurement reflects what your potential buyers must use to pay for your business.

About Risa Baker

Risa is Managing Director of PARTNERS 31. Her natural enthusiasm and years of industry experience will successfully guide your business, whatever its size or specialty, through every aspect of exit planning, from strategy to sale.

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