A verifiable cash flow can determine the price of a business acquisition.
Buyers and business brokers go as far as stating that cash flow is a major deciding factor in a business purchase decision. For buyers, an owner’s discretionary cash flow, secured through a business purchase, is important in determining the value of a company.
Owner’s Discretionary Cash Flow (ODCF) is the amount of money a new owner can take annually from the business. TVG, as a professional business broker, can assist in analyzing the business’ income statement to determine the ODCF. There are common tax strategies that comprise the ODCF; net income, owner’s equity withdrawal and perks, depreciation and amortization, interest expense, and non-reoccurring expenses.
Your federal tax rate is determined by your net income. A common tax strategy is to offset the business profit with allowable expenses, therefore keeping your taxable income low. With this tax strategy in mind, a small net income does not necessarily reflect an unprofitable business.
The owner’s salary is a large component of ODCF. Again, there are tax incentives for paying less employer and employee tax, based on a lower income level. To decrease tax liabilities, business owners will often pay themselves a small salary and make up the difference with owner perks.
An owner perk is when the business pays for personal expenses, a benefit of owning a business. Although a good tax strategy, business paid personal expenses, lowers the net profit. To appropriately value a business for sale, an itemized perk list can be added to the income statement, increasing the value of the business on paper.
Both non-cash expenses, depreciation, and amortization are components of ODCF and used to reduce taxes. Depreciation decreases taxable income but does not reduce cash. It is acceptable to include depreciation and amortization in cash flow calculations.
Interest is a component of ODCF and can be attributable to bank loans, personal loans, equipment leases, and other debt instruments that may go away after the sale. One-time or non-recurring expenses are also considered components of ODCF. Extraordinary litigation expense is a good example unless litigation is an annual occurrence.
Calculating ODCF is an important component when preparing your business exit strategy. Contact The Vantage Group today for help with your ODCF and exit strategy plan.