Knowing and Understanding ODCF – Owner’s Discretionary Cash Flow
It cannot be stressed enough the importance of verifiable cash flow on a small business.
Replacing an income from corporate America is the main drive for a high percentage of first-time buyers. They are typically looking for a small business to “cut their teeth on” for their first or only business purchase.
What is ODCF?
ODCF stands for Owner’s Discretionary Cash Flow, which is simply defined as money able to be taken out of the business annually.
Why is it important to know about the seller’s ODCF?
A high percentage of first-time buyers come from retiring corporate America. Knowing what the seller is considering as ODCF will allow the buyer to know whether they will be able to immediately supplement their previous salary with the business income without dipping into operating costs. It is not just the owner’s salary that is considered ODCF, in fact, this number is often reduced so not to be overly double taxed with payroll taxes as an employee and an employer. There are many categories that can fall into this bucket on a balance sheet.
Main elements that comprise the owner’s discretionary cash flow will include:
Net Income – The amount of revenue after paying all business expenses and before federal taxes have been paid. This can fluctuate to keep taxes down. Though prepaying expenses for a coming year might reduce the net income, it does not mean that the business is not profitable.
Owner Salary – This is not always a large amount as to not overly double tax as an employee and an employer.
Depreciation / Amortization – This is added to ODCF as these things reduce taxes as it decreases taxable income.
Interest Expense – This is not a category that is often taken over by the new owners. All previous owner loans and such type expenses should mostly if not completely be eliminated with the business transfer.
Non-Reoccurring Expense – This is a varying amount as the category suggests. However, it is important to see if the balance sheet can sustain this type of ODCF should the need arise.
Owner’s Perks – This is a common way to offset an owner’s salary. It can include things such as auto expenses, cell phones, travel, insurance and 401(k) contributions.
This overall ODCF amount may end up making a small business more appealing, but make sure it is all well documented.
How does ODCF affect the sale or purchase of a business?
Though it is true that many items can fall into the category of ODCF, a bank may not see it in the same light. This is not as much of an issue if the main financing for the business is seller-financed or the seller kept ODCF to just the basics of owner salary. An SBA or conventional bank will have other regulations to adhere to. Sometimes the only thing a bank will consider when making a determination to fund a business transfer is the EBITDA plus the owner’s salary.