Many factors affect the sale of a business; environment and market conditions, competition, profit and loss… the list is long and variable. But one of those variables worth mentioning today is cash flow. Cash flow can positively and negatively affect a business sale. Why? Let’s first explain what cash flow is…
What is cash flow?
By definition, cash flow is the flow of ‘cash’ (physical or virtual) in and out of your business. For example, your products cost $2 to purchase, you sell them for $10 – giving you $8 cash flowing into your business with every sale. There are several types of cash flow (free, operating and forecast) and they are calculated using the formulas below:
- Free Cash Flow = Net income + Depreciation/Amortisation – Change in Working Capital – Capital Expenditure
- Operating Cash Flow = Operating Income + Depreciation – Taxes + Change in Working Capital
- Cash Flow Forecast = Beginning Cash + Projected Inflows – Projected Outflows = Ending Cash
Once you figure out your cash flow situation, you can determine whether it is positive or negative. NAB has a cash flow calculator tool that helps you identify changes you can make to improve your cash flow. Check it out here!
- Positive cash flow = There is more cash flowing into your business than going out
- Negative cash flow = There is more cash leaving your business than coming in
Now that we know what cash flow is, how does it affect business sales?
There are two main ways cash flow can affect the business sale. The first affects the seller more than the buyer, and the second is the opposite.
- Decreases the business sale price
If the current business owner finds themselves constantly dipping into their funds to cover bills and expenses – that means the business has a cash gap when it comes to cash flow.
If a potential buyer needs to inject a hefty amount of cash into the business to turn a positive cash flow, this will no doubt affect the determined sale price as the Buyer would need to invest more working capital into the business, thereby decreasing the value of the goodwill.
2. Stops the buyer from obtaining a loan
When a new buyer looks to purchase a business, they have two main options in terms of funding the purchase:
For most new business owners, the only option is to get a business loan from a financial institution. Now, this is where cash flow comes into play. To make the loan viable, the financial institution will assess the loan applicant and the business they’re looking to purchase. To make the loan feasible, the debt coverage ratio needs to meet a particular figure (generally 1.25). To calculate the ratio, simply divide the annual cash flow of the business by the total loan amount (total debt). If the ratio is below the minimum figure stipulated by the bank = the loan will most likely be denied.
If you’re thinking about selling your business and want to determine whether cash flow will affect your business sale, contact Core Business Brokers today, on (02) 9413 2977, or email Roy at [email protected] or Rad at [email protected]. Our knowledgeable team will assess your business and provide fair and honest advice when it comes time to sell. Contact us today.