Value Builder Driver #4: The Valuation Teeter-Totter

In this episode of the Business Owner Breakthrough Podcast, Pete Mohr discusses the critical balance between profitability and cash flow, referred to as the valuation teeter totter. He emphasizes the importance of cash flow as the lifeblood of a business and how it can impact a company's attractiveness to potential buyers. The conversation covers strategies for improving cash flow and profitability, including operational efficiency, managing working capital, and focusing on recurring revenue. Mohr encourages business owners to assess their financial health and consider the value builder assessment as a starting point for enhancing their business's value.

Takeaways

• Cash flow is essential for sustaining business operations.
• Profitability and cash flow must be balanced for business value.
• Buyers prefer businesses with reliable cash flow.
• Improving operational efficiency can enhance profitability.
• Recurring revenue streams increase business attractiveness.
• Effective working capital management is crucial for liquidity.
• Shortening the cash cycle can improve cash flow.
• Automating processes can lead to operational efficiencies.
• Incentives for early payments can boost cash flow.
• Regularly reviewing financial reports is vital for business health.

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Transcript

0:00

Welcome back to another edition of the Business Owner Breakthrough. In the last episode, we discussed the Switzerland structure and why reducing dependency on key relationships is crucial for building business value. Of course, this is the Value Builder series and today we're going to talk about Value Builder number four and it's called Valuation Teeter totter. It's really striking the fine balance and that's why we call it the teeter totter of profitability and cash flow and why getting that right is just essential for making your business more attractive to buyers. Essentially, if you've been in business a while, you know that there's this constant balancing act between growing profit and maintaining enough cash flow to fund day to day operations and businesses with high profit margins. But poor cash flow can find it really hard to sustain growth. And businesses with a solid cash flow but thin margins might struggle to find and attract buyers down the road too. Ultimately, buyers want to look for businesses that have both profitability and the liquidity to operate smoothly without requiring constant cash injections by the owner. It's an interesting thing, but a lot of owners don't really feel that cash flow is that important. But you probably have heard this. Down the road, cash flow can kill. And cash flow truly is the lifeblood of any business. And without it, even profitable businesses can struggle to meet their financial obligations. Right. One of my first businesses, we did a lot of work for property managers and probably about 85, 90% of our business was in receivables. And as our business grew and grew and grew, it became harder and harder at a given time there to manage all of the receivables that we had out for 30, 60, 90 days and even past that at that time. And it was a big thing for us to pull that back in and really understand cash flow management in order to have a strong, successful business. Because the business was there, but the cash was tight sometimes. And now in retail we get paid every day when somebody buys the next pairs of shoes. But the other thing is that we owe suppliers for an abundance of inventory that happens to sit in our store in order to make that next sale. So there's these different ebbs and flows of cash that make it so, so important that you're on top of not only your profit, not only your revenue, not only your profit, but your cash flow and cash flow analysis along the way. Anybody who's going to look at your is going to want that reliable cash flow because it reduces their risks into needing and injecting working capital into the business as they take it over Remember, if somebody's looking at your business, they're not probably looking at your business to stay the same. They're looking at your business and thinking about the growth, which we talked about a couple of episodes ago, and how they can finance that as well. Right. Profitability is still important, though, because cash flow keeps the business running day to day. But profitability, particularly operating profit or EBITDA that we had talked about, demonstrates the efficiency of the business and its ability to generate income. You want to have that all very clear in your financial reports, which was episode number one of the Value Builder. If you need to go back and review these previous episodes, go back and review them because they all come together in conjunction with one another in order to make a valuable business your valuable business. So how to improve cash flow and profitability? Well, there are several different ways. First, you can shorten that cash cycle. Like, look at how long it takes you to collect payments from your customers. As I had mentioned, whether it's 30, 60, 90 days, hopefully you're in a position where you can narrow that down. Can you speed up receivables and maybe slow down payables? Is there a way you can work with your suppliers that you can potentially slow that down a little bit so that the cash flow isn't going to hinder your growth if you're looking to bring cash in quicker. One of the things that I had done earlier, early on, was offering incentive for early payments or maybe tightening credit terms for those new clients that come on board, maybe having them pay by credit card right off the bat, if that's the case. You know, there's so many different ways, and it might cost you a couple points, but if cash flow is a real issue, then you want to tighten that up until you get to the point where you're comfortable again. And then you can get those couple of points back and say, hey, listen, you know, we're at 30 days now. I'm comfortable with that. And away we go. Step two on improving cash flow and profitability really is all around improving, improving operational efficiency and to increase profit margins, really, you need to identify the areas where you can reduce waste, streamline your processes, and lower costs without sacrificing quality. Right. There's time, there's quality, all of the different things around here. And I'm sure most business managers look at this one fairly often and know their situations. But if you haven't looked into some of these things, it's probably a good thing to look at for your efficiency. And we have talked a lot about Automating your processes, renegotiate with your suppliers, optimize inventory management. All of these sort of things around operational efficiencies. And most people who are operating their business on a day to day basis are pretty in tune with that, but you still need to look at it on a regular basis. Step three is to focus on recurring revenue. The more predictable your revenue stream, the easier it will be to maintain cash flow and attract buyers. Anything that has a subscription service or maintenance contracts or long term agreements has much more value in the eyes of a buyer and in eyes of a banker. For example, even if you're looking at value valuations around this sort of thing, because they're there, it's proven it's all really about reducing the risk. So step four is managing working capital effectively. Keep enough cash reserves on hand to cover short term obligations, but don't let too much cash sit idle. Balance your cash flow with reinvesting in the business to fuel growth. And one of the things that a lot of small business banks will do is they have have higher interest savings accounts that you can put your excess money into, so it's still available to you. You can also forecast different things along the way where you might put them into short term investments just so that it's not locked away for an extended period of time and it's still available. All of these things around cash flow is such an important piece of managing your cash flow and managing your valuation. Ultimately, buyers look for businesses with strong EBITDA margins, but also want to see that the business has enough liquid to fund its operations without relying on external financing. If external financing is in the picture, that's okay. But chances are the new buyer is going to come in with their own financing and probably change that financing structure. So lots of things to think about here if you're getting closer to the time where you might want to exit. And these are things that are a little bit further out there if you're a little bit further off from exiting. The key thing here is that improving both cash flow and profitability, not one or the other, it's and the the keyword. And both cash flow and profitability can significantly impact the multiple that a buyer is willing to offer for the business down the road. One thing I can tell you is that buyers will scrutinize cash flow forecasts. So make sure that you have everything, all your ducks in order, as much as you possibly can. So I'm going to throw it back to you. How well are you balancing your profitability and cash flow in your own business, are you sacrificing cash flows for profits or are you sacrificing profits for cash flow? It's that balancing act. It's the valuation teeter totter. And you know a good way to start checking this out is to take the Value Builder assessment. All you have to do is go over to theexitreadybusiness.com and click that button. The Value Builder Assessment. It's a great place to start with the benchmark. It'll give you all of your information. It's the starting point for all of these conversations. One of the things the Value Builder assessment too, that I don't think I've mentioned in the previous episodes is there's the last few questions asks you to put in your financial numbers. It's one of the things that you don't need to do. If you do want to do it, it's going to help help me come up with a range of value for you. But you don't have to do that as part of it. You can just get your assessment on the eight key drivers without putting any financial numbers in whatsoever. Happy to do that with you as well. But it all starts with taking the Value Builder assessment. Over@theexitreadybusiness.com the next time we'll dive into the hierarchy of recurring revenue. Really, the predictable revenue streams make your business so much more valuable. How can we prove it? How can we bring it to the forefront? How can we set them up? We're going to talk about it in the next episode of the Business Owner Breakthrough podcast. Now go and make it a great day.