Why Cash Flow is Important When Selling Your Business

January 20, 2021
Final Ascent
Cash Is King

All business owners learn very early in their entrepreneurial life that there is no truer statement than Cash is king!  To echo these sentiments, a long-time CEO friend of mine reminisced, “I never saw a company fail that had lots of cash!  They could always retrench if they needed to, change strategies and hunker down, but they always survived.”

And when business owners are reaching the end game, looking to sell their businesses, they sometimes confuse revenue and profits with cash flow in the business.  They’re living with cash flow constraints and working capital shortfalls they may not even be aware of and buyers use this as a negotiation point to lower the purchase price.  Buyers also know that, as part of a purchase of a business, they will have to fund the working capital shortfalls that may exist in the business operations.

Common mistakes with cash flow

Here’s a common story we see play out with the business owners we guide through the exit planning process, helping them restructure their businesses into “built to sell” companies.

“Sales are going great, so we’re making money, right?” is a common question we hear.  It usually comes from a good place, but oftentimes we see businesses running on a modified accrual method when really they’re downloading their bank statements into Quickbooks and basing decisions on a cash basis.  In a hurry to bring in sales, they’ll typically negotiate net 30 terms and extend credit even further to 60 days or more for the whales, a Walmart or Kroger.  This is all good if they’ve properly extended vendor terms out past the customer terms to cover the shortfall.  But time and again, this is not the case.

Manufacturers and other strategic partners are getting savvy, requesting retainers and down payments upfront to cover their working capital gaps and demanding full payment upon delivery.  What should be good news that you’ve finally landed a national client becomes a nightmare as cash reserves dwindle.  This is almost always matched with two universal truths: 1) you’re selling your products at a steep discount, eroding your margins in hopes of a volume play, and 2) you’re reducing your ability to expand your more profitable client base as cash is tied up in aging accounts receivable.

How to strengthen your cash flow and working capital position

So what do sellers do to strengthen their cash flow and working capital position in preparation for the sale of their business?

“We take them through a series of exercises designed to uncover the cash flow constraints that are crippling their growth and reducing cash flow,” says Steve Conwell, President of Raincatcher, LLC. “We brainstorm creatively with the owners to identify opportunities to improve their cash cycles.  In effect, we’re making cash work for them to fund their growth strategies.”  Asking for retainers upfront, creating monthly payment models that pay for services in advance, offering discounts on net 7 or net 15 terms, and more immediately reduces the number of days receivables are outstanding.

How commissions affect cash flow

We then dive into commission plans to uncover a common problem.  Most owners are happy with increased sales, but this trend does not immediately translate into higher gross margins, which in turn affects bottom-line net profits.  We follow the source, helping the owners evaluate their commission models, which oftentimes reveals the culprit – the sales team is incented to sell based on revenue, not gross margin. It’s human nature to follow the money, and salespeople are incented to offer steep pricing and volume discounts to get the sale and earn their commissions.  Remember, what gets measured, gets done.  This erodes margins and ultimately cash flow.  By changing their commission plans to focus on gross margin dollars, we immediately improve downstream profitability.

Focus on quality clients to improve cash flow

We also look at the company’s customers from a new angle – profitability.  It’s always better to move away from unprofitable clients, and at a minimum, ask them for a higher price to be more competitive. This is really tough for some owners who may have had a number of these customers for years, even decades.  But there’s an old entrepreneurial mantra that successful owners repeat: “You’re here to make money, not sell widgets!”  I jest, of course, but the reality is loyal customers will pay the increase, and your bad apples will leave and go to your competitors, which is not necessarily a bad thing.  We then work hard to create cross-selling opportunities, increasing sales with the more profitable customer base.

Simultaneously, we look at the company’s top vendors to identify any concentration issues, helping the company renegotiate payment terms and at the same time look for new vendor partners to fill the gap.  Owners are often surprised to find that vendors are willing to work for their business and earn it, offering generous payment terms to bring on new business.

Through all this, there is a simple and profound lesson to learn.  Every day we can receive money sooner, combined with more days we can extend and hold onto our money, the more cash we accumulate.  Our working capital reserves become a surplus that significantly improves our growth potential.  We’re able to higher better talent, offer better benefits, create more compelling, competitive products and services, and more.  It’s a win/win for all.

And most importantly, it’s very attractive to buyers who will bid for the company, commanding a higher purchase price and better legacy for the sellers.

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