Mike @ Maxell Consulting
How valuations highlight cash flow issues

Cash is often called king in many businesses, because it is the lifeblood of the “business beast”.  Without cash you cannot pay your bills, develop your business, provide goods or services and most importantly get a benefit from your hard work. 

The real indicator of value is when your “bank balance” has increased from one period to the next (often with some deviations in between).  By “bank balance” I mean not just the business bank balance but also the owner’s bank balance or the level of assets the owner has acquired over the life of the business.  If this hasn’t increased then it is likely the business has not created significant value for the owner.

The value of a business is dependent on future cash flows, but this is not just the same as profit. 

So what cash flow issues impact a valuation?  The following list some of the key drivers:

  1. Profits before interest, taxes and depreciation form the basis of most cash flow.
  2. A decreasing level of working capital helps add to the cash flow as you are freeing up cash by working more effectively.  This can include reductions in debtors, stock and more efficient use of supplier credit.
  3. Reducing the level of debt in the business increases the valuation, not only from reduced interest costs but it also reduces the net debt adjustment.
  4. The lack of cash flow (such as negative cash flow or negative net assets) often increases the percieved risk for a buyer and reduces the valuation.

Many business owners note they never seem to have a growing cash balance or not enough to pay a suitable return for the business.  This is often an indication that the underlying business is not generating sufficient funds to grow or operate the business and instead cash flow is generated from financing activities (more debt).

A valuation will often identify these issues quickly as it must consider the cash funding requirements of future growth and whether the business can sustain these in the long run.  A fast business valuation can help to identify the areas where improvements are needed.

Do you know why your cash flow is always tight?  Do you how much the business valuation is affected by cash flow issues?  Do you know what to do about it?  If you want answers to these questions check out our Your Value NOW process at http://www.yourbusinessvaluation.com.au/

Five indicators of going broke

The biggest killer of value in a business is going broke - insolvency or bankruptcy.  No one will pay full price for a business that is in administration or insolvent.  But the loss of value rarely happens overnight – it comes from a series of decisions and indicators that build up over time.

Insolvency occurs when the business is unable to pay back its debts as and when they fall due. It sounds simple but there is a lot of grey around the term “as and when they fall due”. It has a lot to do with time and the business’ ability to renegotiate its debts.  Insolvency is essentially a question of cash and time – you have run out of both and someone else has decided to act.

Many people think of a business going broke as relating to having lots of debt and unable to meet the interest payments or payout the debt when it is due.  In some cases it may be that a run of losses has soaked up the available capital in the business.  But in reality businesses go broke because of several factors all culminating together - not just one. 

There are two critical aspects to insolvency – cash flow and time.  The longer the cash flow of a business is reducing or is negative (more cash going out than coming in) the more likely it is the business will become insolvent.

It is worth pointing out that I am referring to CASH FLOW not sales or revenue.  The revenue of a business can be increasing over time but the cash flow can be negative.

And there CAN be a long process before a before it reaches this point. So it is worth noting some of the more common warning signs of going broke:

1. Total debts exceed total assets (Negative Net Assets):

·         When total liabilities consistently exceed total assets over a long period of time this becomes a cause for concern.  This may not apply to service-based businesses that primarily have low levels of assets.  As long as cash flow can sustain debt and/or interest payments, negative net assets on its own is not always an issue.

·         If total liabilities continues to increase over time then this should raise concern, but it must be checked against the ability of the business to fund ongoing debt.  

2. Current liabilities exceed current assets:

·         Current Assets less Current Liabilities is often called Working Capital.  Current assets refer to cash, stock, debtors and other “liquid” assets, whereas current liabilities are the debts that must be paid in the current period (month, quarter or year).

·         A negative working capital is usually a strong indicator of insolvency because it refers to the level of “available cash” the business has and whether it can pay its bills on time.  A business that has a negative working capital over one a two year period may be living on borrowed time.

3. Running out of cash:

·         Every business has tight periods when the cash just doesn’t cover all the bills.  In those times a proactive business owner will negotiate with debtors to pay in some different time frame.  The warning signs appear when the business continually runs out of cash, has an increasing number of debts that have been recovered and is incurring more debts.

·         Running out of cash can include suppliers refusing credit or requiring cash terms.

4. Ongoing negative cash flow:

  • Negative cash flow is when there is more cash leaving the business than coming into it.  This is not the same as profit.  You can be reporting losses but have a positive cash flow.
  • Cash flow can often be negative in a business, but it is whether the business has positive cash flow in the long run that matters.
  • Negative cash flow can be caused by excessive debt, falling sales and increasing costs.

4. Unable to raise further funds:

  • Insolvency is about running out of cash and time to pay the debts of the business.  So if you are unable to raise further capital to fund the business then that is a good indication the business is in trouble.
  • This can include an inability to raise funds from either equity (from your own sources, investors, friends or family) or further debt from banks and finance lenders.

5. Behind in paying taxes:

  • No business owner likes paying taxes, but they remain enshrined in law and at some point you will pay some form of tax.  In many cases being able to pay tax is a sign of a profitable business.  It is also true in reverse that if a business is behind in paying taxes this can often indicate further cash flow issues.

Almost all business will face any one of these issues, or in some cases all of them, at some stage in the life of the business.  The question of insolvency is the severity of any combination of them and whether you have the time to address the issues to the satisfaction of the creditor or financier.

Each of these indicators is an input into the valuation process.  Undergoing a regular valuation can provide a good cross check on how serious things may be getting.  The valuation doesn’t need to be formal valuation, but a quick examination of the key issues for your business.

Find out more about the cash flow of your business and how it affects the business valuation at: http://www.yourbusinessvaluation.com.au/

Negotiate your way to success

It seems that most small business owners end up needing to negotiate something about their business.  Whether they are selling their business and need to negotiate a price or settling a dispute or disagreement with business partners, often the dispute must come down to one thing - price.

And so often people get hung up about what is right and what is fair.  Let me assure everyone that there is nothing “right” about the value of a business.  And in some cases it may be unfair - but usually in your eyes. Fairness will always be subjective - it depends on the understanding and values of those involved.

So the key in negotiating a position often has nothing to do with what is right or fair - but more to do with the options and what you value.

In these circumstances there are some key hints:

  • Price is what you pay - value is what you get (Warren Buffet):  So what is the value of you holding your position?  If you want to stay in the current impasse then dig your heals in, build a trench and hold out.  If you want to move forward you need to consider changing your position.
  • What options do you have?  What is your BATNA (Best Alternative to a Negotiated Agreement)?  If your other options are better than the current offer for agreement then take the other options.  Otherwise, reach an agreement and move forward.
  • Always consider the future value of alternatives or the opportunity cost of not reaching agreement.
  • What are the two extremes when discussing the value of a business or shareholding?  What is the minimum the vendor would accept and what is the maximum the buyer will pay?  Knowing these gives you your range.

If you want more answers to these questions, I have a free E-book available at:

http://www.yourbusinessvaluation.com.au/

Woolworths reduces risk buy giving away Dick Smith

Woolworths has just announced the sale of the Dick Smith chain to a Private Equity group.  The surprise (to some) is the price - a mere $20M!

SmartCompany: Why Woolworths gave Dick Smith Electronics away

This would seem like a giveaway to most - but it also suggests some prudent approaches to reducing the risk to the value of Woolworths and focusing on core strategies.

Why does this seem like a give-away?  Lets look at the numbers:

  • Dick Smith had sales of more than $1.5 billion last financial year.
  • Earnings before interest and tax of $24.6 million.
  • Comparable stores sales growth of 4.3 per cent and experienced a 15.4 per cent surge in the final quarter.
  • 75 stores
  • Net Assets reported as $290M

Even on a conservative 5 times earnings the value based on the EBIT quoted above should be more than $100M.

So why give away so much value?

The SmartCompany article talks about Woolworths wanting to focus on other core strategies and business units and that the retail chain takes too much time and resources to implement a turnaround strategy.  Anchorage clearly thinks they can do better, recruiting big retail names and turnaround specialists.

But there is a bigger message here (I believe):  Woolworths sees more pain in the future and the likelihood that Dick Smith may return significant losses meant it was keen to unload the asset at any price.  It was protecting future profits by removing an underperforming business before it turns sour!

This is a risk reduction strategy - it is protecting the future value of the business by minimising future reductions in profit.  This is a central concept in the value of a business - the net present value of future cash flows.

It also highlights the risk and the value of retail businesses.  Woolworths most likely cannot see improvement in the core product lines of Dick Smith.  This sounds a warning bell to many other similar retailers - competition in the electronics consumer goods is going to remain tight for years to come.

Whilst many may raise their eyebrows at the price, I suspect Woolworths is protecting its business and taking into consideration the potential downside of the Dick Smith business rather than focus on the loss of upside.

This highlights another key aspect in realising the value of a business - understanding your BATNA - your Best Alternative To a Negotiated Agreement.  But more about that next time.

Read more of our articles from our library or find out more about what Maxell Consulting does.

sebastienflury:

There is a recurrent question coming to me for really early stage startup, who haven’t incorporated: how do we get investors without giving the majority of shares in my startup from day one?

For people who already have gone through the process, or for experienced people, that seems easy and…

Getting and keeping agreement - between shareholders

Recently, as in over the past 3-4 months, I have seen an increase in the number of clients coming to me with a dispute with a fellow shareholder.  Invariably I see the outcome unfolding, and often it is not a pretty sight.  Shareholder disputes can destroy the value of a business faster than most other factors.  But usually the shareholders don’t realise this until it is too late.

The Top Three reasons I have seen as the basis for disagreement are entitlements of shareholders, commitment of shareholders and the direction of the business.  And they typically boil down to either time or money or both. 

Entitlements:

Usually one shareholder feels the money they are taking from the business does not match their effort or the money other shareholders are taking is too excessive for their effort.

This is often embroiled in perceived inequities between salaries of shareholders.  And the common misconception here is that a director’s time must therefore equate to a particular level of pay.

The key issues that often get misconstrued are the confusion between: remuneration for the management role or “the doing” of the business; the remuneration of directors; and the shareholder entitlements.

These disputes are often based on differing philosophies, however the resolution (or prevention) is embedded in documenting a workable understanding and expectations.

Commitment:

The essence of this dispute is that one party feels their contribution is not matched by others.  There is often a level of “disgruntlement” that one person has put in more money or time / effort than another party.  Sometimes one party has put up finances whilst another party has donated know-how, time, assets or a combination of all three.

Typically this comes about at the start of the business or when a new shareholder enters.  The perceived inequity is either never raised (formally) or never successfully dealt with.

It typically boils over at a later date when there is a need to inject more funds.

When one party questions the commitment of the other party it often highlights a major difference on how each party understands what the other is contributing and what they SHOULD be contributing.

Direction:

In most cases the business usually has a clear direction at the start of a partnership.  Shareholders come together because they have a common vision.  Disputes over the direction of the business often come after a period of time when the performance of the business has failed to meet expectations.

In theses circumstances the dispute is usually over two key aspects:

  1. Failure to agree on the vision or direction of the business (whether new or existing).
  2. Failure to agree on how to reach the vision or the appropriate strategies to use to reach the vision.

This type of dispute can often occur when a business expands and find themselves with more than one shareholder.  Often they have come into the business to help out or because there was a genuine desire to create a better larger business than with just one shareholder.

The methods used to resolve these types of disputes can be very different, but often require a series of meetings facilitated by an independent party in order to reach agreement.

One of the key tools used to resolve disputes is to develop a Heads of Agreement that all parties can sign off.  The success of this approach requires:

  1. Admission and agreement on the issues of dispute.
  2. Agreement on a central target.
  3. Document and agree on the steps to reach the target.

I have found that one of the best ways to get people to agree on a target is to relate this target to the desired value of the business.  Most people can reach agreement on a desired value.  The question then remains how to achieve this value.

More about how to reach this agreement will come later.

Read more of our articles from our library or find out more about what Maxell Consulting does.

Lack of management reporting can tip the balance

There has been a string of company collapses and failures over the past 12 months, with all statistics indicating it is more than 30% worse than the same time a year ago.  In most cases the collapse comes about because the company has more debt than it can handle and a drop in sales have finally taken it’s toll.

The latest small business to collapse has been a kitchen manufacturer/retailer based in Queensland, with stores in all Eastern states:

(http://www.smartcompany.com.au/manufacturing/050580-kitchen-designer-and-manufacturer-collapses-with-200-jobs-at-risk.html)

One of the directors of the Business Recovery Division at HLB Mann Judd has said that the cause for the collapse was a combination of factors, including “…a downturn in trade from the general economic conditions, warehouses were massively affected by the floods particularly in Queensland and it needs a restructure”.

The key point that caught my eye in this case was that “the business needed a restructure”! 

This often suggests that the business was bleeding money in one area and other profit-making parts of the business were keeping it afloat.  Then along comes one or two more unplanned events (floods and downturn in sales) and whammo - the business buckles under the weight of “empty bank accounts”.

The need for a business restructure rarely crops up overnight - it develops that way.  Business conditions gradually change in one market compared to another, another state or product range fails to make budget, stock levels creep up, customers take longer to pay bills and before you know the business has no cash.

As soon as the next crisis, natural disaster or economic downturn happens the business can no longer pay it’s debts and then major creditors (usually a bank or the ATO) step in and take control.

The sad part of this story is this circumstance can usually be avoided with one simple management discipline - reviewing decent financial and management reports and asking the right questions.

So many clients often think they know the business but after some detailed analysis of sales and profits they find out things that need addressing or sometimes suggest a change in strategy. 

A client recently discovered one division routinely performed at a 40% operating profit margin whilst the other division in the business made a loss.  In this case the business switched strategies and acted on some systemic issues that affected the loss-making division.

In some cases I have found business owners don’t even review regular reports other than check the bank balance and call outstanding debtors.

It is usually these businesses that will fall over when finally one more unplanned event tips the scales against them.

So ask yourself three simple questions:

  1. Do you have the funds to pay debts if they were called in?
  2. Given the cash flow you know will happen over the next 4 weeks, can you still meet your obligations?
  3. If you lost 15% of sales could you still operate and what would you need to change to keep going?

If you answer no to at least two of these questions then you need to seek some advice - and quickly - before the next flood, fire or economic downturn.

Read more of our articles from our library or find out more about what Maxell Consulting does.

No emotion in the deal

When you create a business (small or large) you put your heart and soul into the business.  You want it to succeed (however you measure this) and you have certain perceptions about how well it has performed, the benefits it gives your customers and the inherent value in the business.  You have invested money, time and effort as well as feelings, emotions, trust, and even a part of yourself in a creation in which you want to feel pride.

So when you sell this business you are often selling “your baby” - a part of yourself is being sold to another person.  It is natural to have feelings about this.  It is natural to have perceptions, assumptions, ideas or even demands about what the business is worth, what should be done with it and what terms of sale should be maintained after the deal is done.

And this post is not about those feelings!  It is about separating the emotion from the facts in order to secure / close the deal.

How do you keep emotion out of a deal?  Recognise the key components of what you are doing.  You are conducting a PROCESS

What is a deal?

The deal is an agreement to exchange your business for something of equivalent value - most often money.  Although deals can include other things you value, such as a car, a house, a painting, they must be something that you agree is of representative value.

The key is that it is an agrement - no agreement, no deal - no agreement, no contract - no agreement, deal dead, buried, cremated and sunk!

So you need to identify the key requirements to get an agreement.  What do you want and what do the other players want?  What are the minimum requirements for you and what is the MOST the other players will part with?

The most important thing to know is what is the PROCESS you follow to reach an agreement?

The Process to Reach Agreement

When people understand that a deal is a series of decisions that are to be made and they specify the outcome to be reached then process can help take the emotion out of the deal.

Each decision requires facts and information and some criteria to make the decision.  For example, the decision to eat in or dine out needs decisions on the budget, the weather, the location, who is involved and how you will get there.

A deal requires decisions on(among other things) - what is being sold, what will be exchanged, what are the other terms and conditions (T&C’s) of the deal and when will the deal happen (sometimes part of the T&C’s).

The process can be a series of meetings where you reach agreement on each of the decisions.  The outcome of each meeting can be a set of minutes or an updated Heads of Agreement.

The process can be:

  1. Meeting to decide what is being sold.
  2. Assessment of the value of what is being sold.
  3. Identification of key T&C’s of each party.
  4. Discussion of acceptable T&C’s to reach broad agreement.
  5. Detailed discusssion of T&C’s that are sensitive to each party.
  6. Document agreement.
  7. Enact agreement.

Making Decisions

When a person makes a RATIONAL decision, they weigh up the pro’s and con’s of the decision and usually decide on the situation or scenario that results in the best outcome for them.

Implicit in this process are some key assumptions:

  1. The person follows rational decision making based on defined criteria.
  2. They have all the information necessary to make an informed decision.
  3. The information is not based on emotive assesments.

So the best outcome for a particular person will result in an improved circumstance.  This may not always tied up with monetary measures but other subjective things such as a better lifestyle or less stress.  But regardless of the measure, the outcome should be clearly better than the current circumstance.

Any decision that cannot be determined as clearly an improvement on the current circumstances is likely to involve emotion.  Whilst this is not a bad thing - it does mean that other people involved in the deal are not likely to appreciate or understand the decision made.  This is because the decision is being made based on your emotions - not theirs.

Can you pass the “alternatives” test?

A good test of whether the decision has been made on largely emotional grounds is whether you can imagine yourself making an alternative decision in different conditions or circumstances and can you clearly define the difference in benefits (or opportunity costs)?  If you can reasonably see yourself make an alternative decision, chances are you have kept emotions out of the process.  Because you are relaxed with another outcome if circumstances where different.

Sure - have passion about the process, have feelings about the loss of your baby, have feelings about the perception of the exchange. 

BUT DON’T MAKE DECISIONS BASED ON THE FEELINGS!

This will never be an easy skill to develop - and at some point you will fail in separating emotions from the decisions.  But the better deals are done with gusto, with passion and with acceptance that once the deal is done - move on to the next one!

Read more of our articles from our library or find out more about what Maxell Consulting does.

Has your business grown in value?

The Smartcompany website released a collection of facts about the financial year that has just ended:

http://www.smartcompany.com.au/finance/050477-10-fascinating-facts-about-the-financial-year-that-was.html

The two that caught my eye were:

  • Aust sharemarket fell by 11%
  • Aust economy surges and inflation falls (GDP grew by 4.3% and underlying CPI was only 2%).

The second “interesting” fact might turn out to be a major milestone.  Modern western economies have rarely increased GDP by such an amount and at the same time maintained low pricing increases.  What this implies is that the volume of goods and services consumed by Aust has increased in the last FY but at constant (or relatively constant) pricing.  Past growth years in Aust’s recent economic history have been associated with increasing prices.

Given the contraction in the manufacturing industry, this is no doubt representative of increased resources industry activity.  But there are a lot of other contributing factors, such as the support industries to the resource sector and the continued growth of services used by many Australians.

In spite of this growth the Australian sharemarket has fallen in value by 11%!  This is the same as saying the aggregate value of all the companies on the ASX have lost 11% of their value.

In an economy when volumes are increasing at constant prices this can be a concern.  One might argue (and quite successfully too) the fall in the ASX is due to external factors such as Greece and the European debt crisis, reduced demand from China and US economic worries.  In other words the ASX falls are not our fault, and therefore we don’t need to do anything!  WRONG!

The fall in stockmarket values will simply place more demands for companies to increase profits to arrest falling share prices.  This may result in more “austerity” measures for their suppliers - and hence SME’s.

So in fact SME’s may face more tough challenges ahead as the “big guys of town” flex their muscle to regain lost value.  In the face of an increasing cost base from many areas, SME’s will find this hard to achieve unless they plan ahead.

So I have two “easy” questions for all SME owners:

  1. Did your business increase it’s value last year or did you lose value?
  2. How can your business increase it’s volumes with only small increases in prices?

I would love to know your thoughts on the FY ahead!

Read more of our articles from our library or find out more about what Maxell Consulting does.

PR is crucial to creating value

One of the most powerful ways to boost the price of your business is to have more than one buyer competing for your business.  Even better is when they approach you since they see your business as strategic to theirs - they are a strategic buyer!

So how do you get other business owner’s to approach you? (Great question - glad you asked!)

You make sure you promote your successes in business. 

A recent example of this is when an Australian firm promoted they had won the global contract to monitor and report Microsoft’s energy usage and suggest where energy usage reductions can be made:

Australian SME wins contract to monitor Microsoft’s global energy usage

There is no doubt that the main reason behind this sort of PR is to let other prospects know they exist and they are winning significant contracts - a global Microsoft contract is well worth crowing about.  And no doubt this will get the phones ringing.  Nothing helps contribute more to increased value than an increasing revenue (and more importantly profit) trend.

But this press release will also make competitors take note - and other businesses looking to expand into related or unrelated markets.  They do the research on how buying your business will benefit them - then they approach you. This is a superior negotiating position to be in rather than you approaching them - as long as you are ready for any offer or discussion.

They will also have a positive view of your growth and performance and will be looking to explore this rather than you having to justify why your business is such a great acquisition.

Once off PR is not going to generate the same results as consistent PR over a lengthy time period - such as two or three years.  Having a carefully considered exit strategy that feeds into your PR strategy (that will be a component of your business plan!) is important.

So if you want to add zeroes onto the value of your business - let the competition know your wins and then let them come to you!

Read more of our articles from our library or find out more about what Maxell Consulting does.