Small Business Accounting Firms: Keep an Eye on Client Cash Flow

This is the third article in a series about how Accounting Practice Professionals servicing small businesses are acting as the guardians of a great deal of America’s wealth creation. Small businesses in the United States generate over 43% of our Gross National Product and employ almost half of the country’s private sector work force.

Keeping an eye on a client’s cash flow is one way to make sure the company is healthy – and more importantly – is more valuable when it’s time to execute an exit plan.

If Cash is King, Cash Flow is a Kingmaker.

In business, there is almost nothing as valuable as fresh insight. A healthy, detached point-of-view comes in handy for businesses owners who are keeping their eye on the ball – the day-to-day execution of their business. Their wealth is being created one customer interaction, one sale, or one small expense-saving measure at a time. By literally stacking up nickels, dimes and quarters each day small business operators create trillions of dollars of sales, profitability – and wealth.

When it comes to selling a business – the exit strategy – the accounting consultant is frequently the first person who is made aware of the intent to exit after the business owner’s family or partners. As an accounting professional helping an owner get ready to sell a business, you might put hours into helping pull the right financial reports, clean up contracts and loose ends, etc.

Ultimately, a lot of this work is about ensuring the company’s financials are clean, accurate, and defensible. There are many areas where your knowledge of the company’s books and reporting processes is invaluable. Buyers — especially private equity — will scrutinize every line item. Inconsistent records, owner add-backs that can't be supported, or weak balance sheets which could erode valuation can kill an exit deal.

One factor that will affect any future negotiations and ability to find the right buyer is steady, well-managed cash flow. Maintaining healthy, predictable cash flow throughout the selling process can further justify the asking price of the business, reduce perceived risk, and help ensure a smooth transition.

Sunbelt Business Advisors calculates and evaluates cash flow primarily using Seller’s Discretionary Earnings (SDE) or EBITDA. While these cash flow metrics form the core foundation used to price and value companies for sale, they are good tools to use every day to manage a business and keep it on track, regardless of whether a business owner is preparing for a sale.

Here are some of the reasons why cash flow matters so much and how it shapes your client’s overall exit strategy.

Potential Buyers – and Lenders – will pay special attention to cash flow.

Lenders will require current financials and a dip in cash flow will cause red flags and open the door for negotiation issues on asking price. Even short-term fluctuations can create concern. Buyers and their lenders want to invest in stability, and consistent cash flow is one of the clearest indicators of a company’s long-term strength.

Surveys conducted nationwide reveal that around 70% of business sales transactions ultimately fail. Seventy percent! Starting with the right valuation is one thing, clean financials is another; and great cash flow really helps improve the chance of deal success, whenever that deal may occur.

Great cash flow strengthens everyday results – and negotiating power during a sale.

Helping a business owner/client keep a focus on cash flow will not only produce better operating and profit results day-in and day-out, but it’s also really helpful when it’s time to sell the business.

Stronger cash flow puts the owner in a much stronger position at the negotiating table. Strong cash flow indicates a healthy company. Conversely, if buyers see the opposite, it will negatively affect negotiations. Weak cash flow can not only lead to a lower purchase price, but also potential perhaps earn-outs tied to future performance, or more seller financing being built into the purchase deal.

Great cash flow is an indication of stability. That will serve your client well in negotiations with buyers.

Great cash flow can indicate the business can operate without the owner.

Many buyers worry about owner dependency. If the business’s performance declines when your client steps back from daily operations, potential buyers may perceive risk.

Strong cash flow tells a much better story. It demonstrates that systems are well-established, the company staff can manage operations, and that customers are more likely to keep supporting the enterprise regardless of who owns the business.

This makes this company more attractive—and often more valuable—to potential buyers. A company that runs on the owner's relationships, approvals, and presence is a higher-risk acquisition. Buyers pay premiums for businesses with capable management teams and associates and documented processes. While helping the owner realize that he or she may need to stay on for a pre-determined length of time after the sale is important, so is putting systems in place to ensure the ‘business can run itself’. Strong cash flow is a solid indicator of that fact.

If you have a client preparing to sell a business, there are a lot of common-sense actions to take if your they haven’t done so already. Tightening up account receivables, avoiding unnecessary expenses or investments, and keeping inventory at optimized levels are all good practices. So is focusing on increasing recurring revenue where possible.

Every improvement matters. And no one knows that better than accounting professionals who see ‘behind the curtain’ of their client’s business.

It’s important work.

Do you believe your clients are prepared for an exit? The successful transition and continuity of your client’s business impacts employees, vendors, customers, charities, and surrounding communities for whom they provide jobs and social well-being. For all these reasons getting an exit plan done and getting it right matters.

As a trusted advisor to your clients, keep exit strategy on the strategic “To-do List” and please, let me know if you have any questions on a business valuation process for one of your clients.

Please call me with any questions. 612-964-8884

Matt Sobieski