Wednesday, February 22, 2012

Factor #3 of 10: Cash

Working capital requirements

In the Self-Assessment, we asked you this question:

  1. We receive payment:
    1. in advance, before shipment and/or delivery.
    2. as a partial payment (a deposit) in advance before shipment or delivery.
    3. upon shipment and/or delivery.
    4. after invoicing, within 15-30 days.
    5. after invoicing, within 30-90 days.

For the business owner balancing cash flows and working capital can be one of the most challenging business problems. Cash flow and timing of positive cash flow is the life blood of a business.

Every business requires working capital. For accounting purposes working capital is defined as Current Assets minus Current Liabilities. In reality working capital is the cash flow required to sustain the business between the moment the product or service is offered, to the point in time where the customer’s payment enters the cash flow of the business. The working capital covers the Cost of Sales, the fixed cost and the variable cost for that interim time frame. There are a number of popular financial models to calculate working capital requirements.

A simple example for how a business is sold: In the case where the business only sells their assets (which indicates the business owner is still responsible for the liabilities), the Buyer uses those assets to create cash flow going forward. For this type of transaction the Buyer is responsible for the cash flow requirement or working capital to sustain the enterprise from day one to the point where the customer’s payments enter into their cash flow.  The Buyer provides their own working capital.

In the share sale model, most Buyers will expect to see some portion of working capital to remain in the company as part of the transaction. While the working capital calculations vary based on the cash flow model of the business, the business owner should be prepared in advance for this discussion.

The business owner will need to demonstrate the financial impact on cash flows for the type of service or product provided. This identifies the funds required to cover operating cost for time required until revenues/cash flows enter the business. The business owner who clearly models working capital requirements and timelines for cash flow demonstrates a business model which the Buyer can immediately understand. Buyers typically perceive a business with a clear working capital financial model as having a higher value because they are able to understand and model working capital requirements and avoid surprises.

  1. Review the timeline between the receipt of an order/sale and when payment typically received. (i.e. 60 days)
  2. Calculate cost/overheads/fixed variable expenses for that period to estimate working capital requirement.
  3. Look at your month by month cycle for the year and determine your minimum and maximum working capital requirement for your fiscal year. i.e.: In Summer may be busier than winter so more working capital is required.

Thursday, February 16, 2012

Factor #2 of 10: Profit

Profitability/Positive cash flows

In the Self-Assessment, we asked you this question:

  1. Profit before Tax is calculated before bonuses, dividends, and adjustments for reducing tax consequences. Our profit levels have:
    1. remained pretty consistent for last 3-5 years.
    2. increased year over year for last 3-5 years.
    3. included 1 negative year showing a loss in the last 3-5 years.
    1. 2 or more negative years showing a loss in the last 3-5 years.
    1. been consistently negative over the last 3-5 years, we are structuring for growth or struggling to develop profit.

While there are many reasons to buy a business, the primary motivation driving the decision to buy is to receive the future positive cash flow as the return on investment. A business that is consistently profitable has a higher value and will be easier to sell than the business with marginal net profit or a history of profits and losses.

Typically the profit before tax number on your financial statements includes various year-end adjustments i.e.: bonuses, dividends, management fees, income splitting, etc. Modeling or normalizing the true discretionary cash flow or the “benefit to owner” allows the Buyer to understand the actual cash flow model for the business. The Buyer will use those numbers to calculate the proforma cash flows which enable completing a return on investment model.

Most share sale transactions will take those normalized numbers to build the criteria for establishing a multiple to set the transaction value.
For example: 3.5 X profit before tax (normalized average for last 3 years).
This means the Buyer will work for 3.5 years to recover the purchase price (breakeven), all things being equal.

When the Buyer reviews your year end statements and your year to date performance, they will be looking for evidence that all things remaining equal, the business will continue to perform as it has performed in the past. The more stable those numbers the easier it is for the Buyer to develop confidence in your model. When your business profits increase year over year for three or more years, the Buyers will recognize growth as part of the future cash flows. When profits are declining, that same trend will be applied by discounting future cash flows and reducing the price.

When those year-end numbers vary for whatever reason the business owner has to be prepared to demonstrate why that happened. The Buyer will need to know the likelihood the lower profit numbers will happen again. Then the Buyer will determine how much to discount the future return on investment numbers. In cases where one particular year was higher than other years, the Buyer will want to understand that case as well. It is important to remember that one year does not make a trend.

The variance in year-end normalized profits is a fact of life. Understanding those profits and why they vary will help the Buyer apply the best cash flow modeling rules possible. This helps the business owner and the Buyer develop a fair cash flow proforma which helps both parties build a realistic value for the business.

TO DO: What three priorities can you identify to improve your profit going forward?

Tuesday, February 14, 2012

Factor #1 of 10: Revenue

Source of the revenues (Repeat/recurring/individual)

In the Self-Assessment, we asked you these questions:

  1. Our business generates revenue by charging:
    1. over $10,000 per transaction.
    2. $1,000-$9999 per transaction.
    1. $100-$999 per transaction.
    2. $1-$99 per transaction.
    3.  based primarily on an hourly rate work.

  1. Our business generates:
    1. 100 or more invoices per month.
    2. 50-100 invoices per month.
    3. 10-49 invoices per month.
    4. 1-10 invoices per month.
    5. invoices seasonally, or some months we don’t generate any invoices.

Business models which generate $10 per transaction and do 1000 transactions a day are considered more valuable than businesses which generate $1,000,000 invoices once or twice a year. While higher revenues initially attract more attention, the reality is operating expenses happen every day.  Having reliable and regular cash flow to cover those ongoing expenses tends to be perceived as less stressful for the owner.

Business models which engage a client/customer once in a lifetime are perceived to be of less value than businesses models where clients return for services on a regular basis. For example: While everyone eventually requires a funeral home the best situation for that funeral home business owner to find new business is to provide such a high level of service for each ceremony, visitors develop a positive impression for future reference. This can be a very long business development cycle. Or, in the case of selling and servicing a product like a home furnace or water heater, customers will require timely and regular service and maintenance.

As long as you provide a quality service for a competitive price, the client will most likely continue to use your company providing your business with recurring revenues.

TO DO: What three priorities can you identify to improve your revenue model?

Monday, February 6, 2012

11 Point Self-Assessment for Sale-Ability of YOUR business

As the business Owner, the responsibility for the success or failure of the business depends directly on you.

Over the last 10 years MAXIMA has created a number of tools to assist the business Owner to develop an understanding or a “Report Card” of how the business is growing in value. To recognize that value most businesses would have to be sold.

MAXIMA uses information on how ownership operates their companies, along with their financial performance to determine a model demonstrating “sale-ability”.

A sample report looks something like this:

By making use of basic guidelines from our in depth evaluation, we have created a self-assessment for you to use as a guide in determining your sale-ability as a company in the BUYER’S eyes.

This Sale-Ability model is not designed to determine your company’s value. This report is designed give you insight into what the typical buyer likes to see before you initiate selling your business. Proper preparations help you to achieve the highest value or greatest return on investment when selling your business.

MAXIMA’s Business Sale-Ability Self-Assessment Questionnaire
Pick the ONE answer from each of the below statements that BEST describes your business. Although your exact situation may not be listed, please pick the closest response for the purpose of this self-assessment.

1.     Our business generates revenue by charging:
a)     over $10,000 per transaction.
b)     $1,000-$9999 per transaction.
c)      $100-$999 per transaction.
d)     $1-$99 per transaction.
e)      based primarily on an hourly rate work.

2.     Our business generates:
a)     100 or more invoices per month.
b)     50-100 invoices per month.
c)      10-49 invoices per month.
d)     1-10 invoices per month.
e)     invoices seasonally, or some months we don’t generate any invoices.

3.     Profit before Tax is calculated before bonuses, dividends, and adjustments for reducing tax consequences. Our profit levels have:
a)     remained pretty consistent for last 3-5 years.
b)     increased year over year for last 3-5 years.
c)      included 1 negative year showing a loss in the last 3-5 years.
d)     2 or more negative years showing a loss in the last 3-5 years.
e)     been consistently negative over the last 3-5 years, we are structuring for growth or struggling to develop profit.

4.     We receive payment:
a)     in advance, before shipment and/or delivery.
b)     as a partial payment (a deposit) in advance before shipment or delivery.
c)      upon shipment and/or delivery.
d)     after invoicing, within 15-30 days.
e)     after invoicing, within 30-90 days.

5.     Our business has:
a)     full control of the manufacturing and distribution of products.
b)     full control of our services offerings.
c)      distribution contracts with more than one supplier with competitive terms and conditions.
d)     various systems in place to access products and services as we require them.
e)     a distribution contract with only one major supplier.

6.     Our business’ client list is:
a)     broad, no one client or customer list provides more than 10% of our revenues.
b)     fairly broad, no one client provides more than 30% of our revenues.
c)      reliable “walk in” high traffic customers, with a history of solid volumes.
d)     based on “walk in” low traffic customers, volumes goes up and down.
e)     narrow, we have one client that provides 60% or more of our revenues.

7.     Our business has:
a)     very little or no competitors, we are the industry leader.
b)     a few competitors, however we have a measurable competitive advantage and customer loyalty.
c)      many general competitors, however we maintain a measurable competitive advantage due to offering a product/service our competitors are unwilling to match.
d)     been struggling to keep up with our competitors.
e)     many large national competitors, we are a small local business that focuses on lowest price to get customers.

8.     In regards to our financials, as the business owner:
a)     I review with my accountant the status of all ratios on a monthly basis to make sure all data is accurate, reliable, and meets our creditor requirements/commitments.
b)     I am very comfortable understanding the balance sheet and debt ratios.
c)      I am still trying to learn what the balance sheet and debt ratios tell me.
d)     I focus on other areas of the business and rely on my bookkeeper or accountant to advise me of any questions regarding the balance sheet or ratios.
e)     I feel our business model does not require us to monitor ratios or our financial statements on a regular basis. We only track what we need to know.

9.     Our business has:
a)     developed a solid product offering to meet and exceed the needs of our broad client base consistently over the fiscal year without significant seasonal variations.
b)     several product offerings to meet general market requirements consistently over the fiscal year with acceptable seasonal variations.
c)      a product we sell to the general market with some variations in activities levels over the fiscal year with seasonal variations.
d)     a product we sell to a sector of customers. We have significant seasonal variations in activity levels over the fiscal year.
e)     a product we sell through a few special events with a modest amount of activity the rest of the year.

10.  Our business process and infrastructure operates:
a)     consistently, allowing me to take extended time away from the office as my staff know how to address almost all situations.
b)     reasonably consistently, allowing me to take regular time off without much impact because I maintain regular communications with management.
c)      reasonably consistently when I am directing and interacting with team members regularly/daily.
d)     with my daily involvement.  I am beginning to reduce my hours to a reasonable level.
e)     only with my daily involvement.  I work extended hours to ensure things are running smoothly.

11.  Our business is supported by:
a)     clear and understandable operations and process manuals our management team established through detailed assessment and analysis. The appropriate response for the majority of situations is documented, allowing individuals not involved in the day-to-day operation to understand and complete appropriate operational decisions.
b)     by a clear and understandable operations manual where existing management would be required to assist in determining the appropriate responses to situations.
c)      an operations manual and a management team who generally make good operational decisions.
d)     a management team which is under development and an operations manual that is a “work in progress”.
e)     my knowledge as the business owner. The buyer from outside the business would require considerable training to understand this business.

Add up the total number of each letter, and give yourself points:
a = 5 b = 4 c = 3 d = 2 e = 1

Green: 40-55

Yellow: 25-39

Red: 11-24

IMPORTANT: this is a very basic self-assessment.
MAXIMA’s proven analysis process includes various tools and methods to determine whether or not your company would be “sale-able.” The results of this quiz are to serve as a guideline to assist you in learning how a potential buyer may view your company. This process helps you identify key areas that may benefit from improvements. 

MAXIMA does not recommend you make any financial decisions based on the results of this test. Please contact MAXIMA or your advisor before you make any final decisions regarding your company.

In the next few posts we will discuss each of the 10 Factors used for this Sale-Ability report card. We will explain why they are important to a potential buyer and how they could potentially add value to your business. As the business owner you can determine if you should focus on certain strategic areas to enhance the value of your investment in your business.