What Happens to Cash When Selling a Business?
COVID-19 has radically changed how owners manage their businesses, and Deloitte recommends an increased focus on cash flow. The amount of cash the seller must provide in a business sale depends on a number of factors, and working capital is often used to determine how cash is included in the sale.
Reviewing working capital
Working capital is defined as current assets less current liabilities, and this metric assesses your firm’s liquidity.
Current assets are defined as cash and assets that can be converted into cash within a year. Current asset accounts include:
Cash and cash equivalents (i.e. money market balances)
Accounts receivable
Inventory
Businesses expect to collect accounts receivable balances in cash within 12 months. In a similar way, the inventory balance should be sold to customers (and cash collected) within a year.
Current liabilities are obligations that must be paid within a year, including accounts payable and the current portion of long-term debt. For example, if you owe $5,000 in principal and interest payments on a loan over the next 12 months, the amount is posted as a current liability.
Liquidity is the ability to generate enough current assets to pay current liabilities. Solvency, on the other hand, has a long-term focus. If your business can generate assets to finance capital improvements and to pay down long-term debt, your firm is solvent.
Using the working capital
Some sale negotiations use the working capital ratio to determine the amount of cash that must be included in the business sale. The working capital ratio is current assets divided by current liabilities.
Assume that you’re selling a landscaping company and that financially healthy businesses in the industry have a 1.4 working capital ratio. Here are the steps to determine the cash balance required for the sale.
Using the most recent balance sheet as guidance, the sale requires $1.4 million in current assets and $1 million in current liabilities.
Accounts receivable, inventory, and prepaid assets total $1.1 million. Cash is the only other current asset.
You must include $300,000 in cash to reach the required $1.4 in current assets
This example assumes that the entire business is being sold. Some sales do not include all of the seller’s assets and liabilities.
Impact of an asset sale
An asset sale includes specific assets, and not the entire book value (assets less liabilities) of the seller’s business. Assume instead that the landscaping company is selling its customer list, the accounts receivable balances, company name and logo, and some equipment. The seller will keep most of the equipment in order to start a tree service business.
In this case, the cash balance and some other assets are excluded from the sale.
These financial decisions are challenging, particularly if you don’t have a background in accounting or finance. You’re busy managing a business, and it’s difficult to find the time to work on a business sale. Find an experienced business broker to help you through the entire sale process.
Marketing your firm’s business value
What is your business worth? The answer is a big factor in the price you ultimately receive for your company, and a broker can help you uncover your firm’s value proposition.
Successful companies are reliable and understand the needs of each client. Many firms work with the same customers for years and increase revenue through referrals. The best companies can grow the business strictly through referrals and spend very little money on marketing.
Once the broker identifies the traits that make your business valuable, he or she will create a document to market your business.
Finding qualified buyers
A broker’s most valuable service may be the ability to find qualified purchasers for your company. If you’re managing your business and working on a potential sale, your time is limited. Nothing is more frustrating than investing time with a bidder who doesn’t have the financial resources to make a serious offer.
Brokers use their network to find potential buyers. If a buyer is interested, brokers work to verify that the purchaser has the financial ability to make a purchase. You’ll spend less time on the sale process, and you’ll find a qualified buyer in less time.
Preparing for due diligence
Once a potential buyer is identified, your broker will help you prepare for due diligence. Your broker will have each bidder sign a non-disclosure agreement (NDA) before any documents are shared. The NDA protects you from an outside party who wants to use your business data to compete against you.
You’ll need to provide financial statements, customer lists, marketing plans, and your organizational chart. Brokers know what information is needed, and will keep the process moving on your behalf.
Determining the business valuation
The experts at Raincatcher provide business valuations, based on their years of experience, industry knowledge, and accounting standards. A valuation is important because it serves as a starting point for the sale price negotiation.
You hire professionals to provide services to your business, and you need a business broker to advise you on your business sale.
Find a trusted advisor
The team at Raincatcher understands how hard you’ve worked to build your business, as well as the financial impact of a successful sale. Their brokers help you market your business, find buyers, prepare due diligence, and negotiate a sale price. Work with Raincatcher today to sell your business in less time.
