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Monday, November 16, 2009

In Selling Your Business, Cash Flow is Everything.

People often ask me how much their business is worth. The answer is: you probably won't be able to sell your business for more than five times the true cash flow of your business.

What is Cash Flow?
Actually, there are several ways to measure the amount of money that flows in and our of your business; and each one differs in important ways from the others. Here are some typical measurement methods.

EBIT: That is: Earnings Before Interest and Taxes. EBITis calculated by subtracting the company's "operating expenses" from its "operating income." Operating expenses are your ongoing costs such as sales and administration, or research and development, as opposed to production costs. The operating expenses for a real property management venture would be:

* accounting expenses
* license fees
* maintenance and repairs, such as snow removal, trash removal, janitorial service, pest control, and lawn care
* advertising
* office expenses
* supplies
* attorney fees and legal fees
* utilities, such as telephone
* insurance
* property management, including a resident manager
* property taxes
* travel and vehicle expenses

Of course, using EBIT does not give your prospective buyer the whole picture because it excludes the businesses production costs, which might be substantial.

EBITDA: This is an acronym for "Earnings Before Interest, Taxes, Depreciation and Amortization" and, while it is frequently used as a means for valuing a business, it is not truly a measure of cash flow. It is actually a way to calculate operating profitability before non-operating expenses (such as interest) and non-cash charges (such as depreciation and amortization) are deducted. The problem is that taking out what can be really big expenses, such as interest and taxes can make even money-losing ventures look healthy on paper. Also, these figures are very easy to manipulate. Some good examples of companies that fell into this category were found in the "dotcoms" of ten years ago. They had no hope of every showing their shareholders a dividend, but they became very popular investments based on EBITDA figures.

True Cash Flow or Operating Cash Flow: This is the amount of pre-tax money that is actually distributed to the owners. It allows for the deduction of the big expenses including depreciation and amortization, as well as changes in working capital that either use or provide cash to the operations. The amount distributed includes salary, bonus, distributions, and rental payments that are in excess of the fair market rental values for the equipment and/or buildings used by the business.

You can see that each of these forms of measurement will produce a different cash flow amount, and therefore a different sale price for your business. The challenge for a business owner is to understand the true value of the business and to set a realistic asking price. By taking time to do a careful analysis of your True Cash Flow before you begin to think about your asking price, you are building the foundation for a successful, and profitable sale. Of course, to manage a truly successful sale of your business, you should rely on the advice of competent professionals including your tax accountant and your attorney. Feel free to call us (617-369-0111) or write

1 comment:

  1. I agree with you completely that cash flow is very important when it comes to selling a business but also remind them that the sales price does not always equate to the valuation. See that I wrote in my blog about here