Most business owners with whom I talk about a possible acquisition by another company are obsessed with revenue and revenue growth. They are usually under the misconception that when the time comes to sell their businesses, the sales price will be calculated as some multiple of revenue. Not so.
At Cobb Technologies, for every acquisition, we based our valuation on how much cash the company would generate for us over the next few years. As a potential buyer, I don’t care if your revenue is 2 million or 20 million. If it costs 3 million or 25 million to generate that revenue, I’m not interested in buying your company. Without a positive cash flow, you will eventually go bankrupt.
Tight cash flow causes undue strain on a small business. Your ability to pay bills in a timely manner helps build a positive relationship with your vendors. If you are ever in a bind, they are more likely to work with you on a short-term solution. In addition, expansion is impossible without some cash in reserve. When applying for a loan to expand, you must demonstrate a reasonable ability to pay your bills. When I managed the finance department for small businesses, each day I insisted upon seeing an update and tie-out of our operating bank account. Some may have thought it extreme, but I always knew exactly how much cash we had available for the business.
Several years ago, I examined a company that looked very good based upon its profit and loss statement. It had strong margins and net income was almost 10% of total revenue. However, the balance sheet told a different story. The company was in a perpetual overdraft state with regard to its cash accounts. Accounts receivable were out of control due to recent personnel changes and lack of focus. Outstanding amounts that were over ninety days old made up about 25% of the total accounts receivable balance. Anyone who has worked collections knows that when an account hits the ninety-day mark, the probability that it will be 100% collected falls dramatically. On the payables side, things were almost as dire. The company was behind on payments to all their major vendors and had been put on a cash with order status with most. Getting needed supplies and parts to customers under a service contract was becoming impossible. Eventually, this once strong and profitable company would lose valuable customers unless action could be taken soon. It is amazing how taking your focus off one key area of the business can have a disastrous effect on the business. Ultimately, a company’s access, or lack of access, to cash will determine whether it survives.