In our last post, we uncovered how minimizing one’s risk profile is a great start to enhancing business value. The second piece to the valuation puzzle is responsible use of a company’s available cash flow.
Improve Available Cash Flow
While minimizing risk is critical to enhancing the value of a business, one must also keep a pulse on how a business is utilizing its liquid capital on a day-to-day basis. Obviously, improved revenue or reduced expenses will also increase value, but in most cases, this is easier said than done. Sometimes advisors don’t have the knowledge to advise their business owner clients on where to make cuts and grow revenue, and those recommendations may be dependent on the industry. Figuring out how to increase a company’s cash flow can be the hardest part of the puzzle. That is why if you are creative and break down the process into tangible steps, cash flow management doesn’t have to be so overwhelming.
Make a Budget
It is important to compile a realistic monthly budget of all income and expenses each year. This will be extremely helpful to the business in the long run to see patterns in cash flow. Compare these budgets to actual results to identify where you might be able to make some adjustments to control spending or opportunities to increase revenue. Set revenue goals so you have a clear idea of where you want your cash flow to be by a certain point in time. This will also help you understand in which areas you might have a little extra cash or where money might be tight.
Analyzing expenses can be a stressful and difficult process for some business owners. The sooner they sit down and take a good hard look at the actual results, the sooner they can start making changes for the better. This process also might alleviate the stress of any unexpected cash flow fluctuations. Keeping a close eye on changes can help your clients better plan for the future.
Analyze Finances
Compare your finances to your peers in the industry to see where they stand and understand what they might be doing well and where they might need to improve. As we all know, a company is always growing and changing. To be successful, it is critical to compare a business to its competitors to stay ahead of the curve and stand out. Otherwise, your business can become obsolete and the revenue stream will suffer even more.
Empower the Employees
The employees are the life blood to the success of your client’s company. Creating compensation and incentive plans based on employee productivity or performance will significantly impact cash flow. Set goals for key employees to hit based on the revenue goals and reward them handsomely. Employees don’t necessarily have to be rewarded with money but be sure the reward has enough value for them to work hard enough to attain it. The company will make more money, top performing employees will get rewarded; it’s is a win-win opportunity for everyone.
No Quick Fixes
Some people believe they can fix cash flow or valuation issues overnight. We promise you that this is nearly impossible.
Modify Owner’s Paycheck
Obviously, if a business owner decided to take a pay cut, they would see slightly improved margins. However, often buyers will consider this and reevaluate the accurate compensation the owner should be allocated and adjust their valuation on their own. So, at the end of the day, taking a pay cut won’t really help anyone and will most likely just result in a frustrated owner. However, if the owner strategically takes cash out from their paycheck to invest in new projects for the benefit of the business, this could grow the value of the company and have a larger impact on the company’s cash flow margins.
Focusing on Lowering Company Debt
Although paying down debt is always beneficial and financially responsible, this will not have a huge impact on the value of your client’s company in the near future. Consider your mortgage for this example. Your house is typically worth the exact same amount whether you pay off your mortgage or not. Furthermore, if you use a large amount of cash to pay off your mortgage, you won’t have the available cash flow to invest in other areas. Paying down debt won’t change the valuation of the business by that much, but you would see the impact after the business is sold and the cash lands in your pocket.
Overall, there is not a true quick fix to minimize risk, increase cash flow, and enhance business value, but it is encouraged that you take small steps over time which can make a huge difference.
As we have learned, cash flow can be very sensitive and various decisions could greatly impact a company’s projected cash flow and overall business value. Like many things in life, we may not always understand the direct downstream effects of our actions, but cash flow is one factor of a business that cannot be ignored. It plays such a large part in reaching an owner’s goals of transferring the business when they want, to the person they choose, and for the money they need. It starts with reviewing cash flow today and properly managing in the future.