Articles Tagged ‘Cash flow plan’

Cash Flow Forecasting: The Ultimate Reality Check

Tuesday, March 20th, 2012

Presented by T. Ray Phillips

In past articles, we have looked at why cash flow is so important to third party buyers, and by extension, to sellers of closely held companies. In short, a seller must demonstrate an increasing stream of cash flow from the business. Without a healthy cash flow, a buyer may pass over the opportunity to buy your business in favor of purchasing a “good” company with less risk.

In this article, we will examine why cash flow is also crucial to those owners who wish to transfer their companies to insiders (employees, co-owners or children) and how to allocate cash flow.

Let me suggest the following definition of cash flow. Business cash flow is the portion of the annual net cash flow from operating activities that remains available for discretionary purposes (after the basic obligations of the business have been met). Because we are discussing cash flow in the context of exiting your business, the “discretionary purpose” referred to above is the purchase of your ownership in your company.

As you prepare to transition out of your business (using any type of ownership transfer other than liquidation or, in some cases, a gift of the company to your children), it is imperative that you secure an accurate future cash flow model. Why?

In a sale to insiders (employees, co-owners or children), cash flow may be the source—the sole source, at least initially—of payments to you. Insiders may not have enough money of their own with which to pay you. Without significant planning and implementation, insiders may not be able to quickly acquire or borrow that cash.

If you choose instead to sell to a third party, the valuation upon which buyers make their offers is likely to be based on a multiple of cash flow.

Should you plan to sell part or all of your business beginning in 2012, your CPA should make cash flow projections for 2012, 2013, 2014, 2015 and 2016.

If you are preparing your own cash flow projection, resist the temptation to create an overly-optimistic forecast. Your projection must be grounded in the reality of past actual performance rather than in your rosy hopes for the future. To avoid this temptation, owners usually ask their CFOs or CPAs to create these forecasts.

With a realistic cash flow projection in hand, you can begin to plan the most tax-effective way possible to achieve that future cash flow.

It bears repeating here that the future cash flow of the business may be your buyer’s only source (at least in the early years) of funds to pay you. If the company, under new ownership, cannot achieve the cash flow numbers that you project, you may not receive the payoff that you expect.

How to Use the Cash Flow Forecast

Forecasting cash flow is the first step. The second is to calculate how that cash flow will be allocated during the ownership transition. Determining the net after-tax distribution to you is the goal of this exercise.
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Worry Less about Money with a Cash Flow Plan

Monday, November 14th, 2011

One of the biggest stresses in business ownership is having enough money. Enough money to pay employees, pay ourselves, pay vendors and pay for growth. Money is the grease that keeps the business machine running and if we are unable to lubricate our business adequately it does not perform well.

Here are some actual real world examples:

One of your long time customers wants to increase purchases by $50,000 a month; but need extended terms from 30 to 60 days. This represents a 30% increase in revenue for the next 12 months. Your line of credit maxes out on a regular basis. Should you do it?
You have an opportunity to purchase a new piece of equipment that will increase production and revenue by 20% a month. The equipment costs $300,000, revenue will increase $1,400,000 for the year, inventory and accounts receivable will increase $350,000. Profit is projected to increase $250,000. Should you do it?
Your industry is experiencing dramatic raw material price increases. You need to raise your prices to your clients but cannot raise them too quickly in fear of loosing customers to your competition. Your lender has already said they will advance you enough working capital to bridge the inventory growth and transition to the higher prices; but they want to see when you will be able to pay back the extension. How do you prove to the bank that this will work?
The best solution to these three and a hundreds of other “money” issues is the cash flow forecast. What is a cash flow forecast?

It predicts your uses and sources of cash on a monthly (or weekly) basis to determine if you have enough cash to operate effectively.
The forecast is predicated a lot on what you have planned or projected in your profit and loss statement – revenue, expenses and profit.
It also takes into consideration any cash influx or out flow that doesn’t affect your profit and loss statement – line of credit uses, principal debt repayment, distribution (dividends), accounts receivable collections and accounts payable days outstanding.
It is a forecast — so it can be updated any time you feel it is important to update your cash flow forecast. It is recommended that it be done at least monthly and for those companies with cash flow troubles – do it weekly.
How do you create a cash flow forecast? There isn’t a boxed software program that I am aware of that will create a decent, forward-looking cash flow forecast. Most of them have to be built on an excel spreadsheet. They are not hard to do; but they take understanding of how your business works and the critical elements of how cash flows through your business. Once you have one, you can use it extensively to help you answer questions like those I presented at the beginning of this article.

Dan Lacy
Growth & Profit Coach, Financial Strategist, Cash Flow Doctor, CEO Mentor
dan@dynastybuilder.com
phone: 765-644-8887

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