An Estimate Of Future Company Cash Flow
The Fifth Of Five Elements In Every Successful Exit Plan
This issue is the last in our series about the five elements of every successful Exit Plan. As a quick review, the first four elements are:
(For copies of the first four issues, please email Kevin Short at email@example.com.)
In this issue, we look at why securing a professional's estimate of your company's cash flow is crucial to the success of your Exit Plan. Any buyer, whether an outside third party or an insider (family member, co-owner or key employee) will use cash flow as a way of measuring the value of what they are buying.
While there are many definitions of cash flow, one that we use is Free Cash Flow. Free Cash Flow is the portion of the annual net cash flow from operating activities that remains available for discretionary purposes (after the basic obligations of the business have been met). In this situation, the "discretionary purpose" is the purchase of the owner's interest in the company.
If you are contemplating a sale to insiders, remember that they generally have little cash to finance the purchase. It is the future cash flow of your business (once you leave it) that funds your buy out. As you can see, in transfers to insiders, cash flow is both the measure and the means of the ownership transfer. For that reason, it is important to estimate cash flow as accurately as possible.
Once you know an estimate of future cash flow, you can assess various exit paths and your advisors can design an exit strategy that puts as much of that cash flow as possible in your pocket (and as little as possible in the IRS's coffers. Remember, every dollar the IRS takes is one dollar less paid to the owner-regardless of whether the buyer or seller pays the tax.
Let's assume for a moment that your CPA or valuation specialist estimates your company's cash flow and tells you that it cannot support all of your exit objectives. You and your advisors will then explore alternatives such as:
Securing an accurate estimate of future cash flow prevents you from choosing an exit path that is a dead end. Like the valuation, estimating cash flow costs money but your costs should be minimal if your financial reports are in good order. Of course, if your post-retirement needs are modest and your company's cash flow great, calculating cash flow may not even be necessary. For most owners, however, calculating cash flow is an integral part of creating a successful Exit Plan.
Subsequent issues of The Exit Planning Navigator® discuss all aspects of Exit Planning.