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How to Build a Business to Sell

High-growth, successful businesses are a result of a number of factors, none more so than planning and beginning with the end in mind. Consider this three phase approach to potentially and dramatically raise the sales value of your business.

Greg Fisher

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Research shows that business owners generally take home less money each month than their corporate executive counterparts, yet business owners are, on average, more wealthy than corporate executives. The reason for this is that much of the business owners’ wealth is tied up in their businesses. To realise this wealth they need to sell their business at some point in time.

A small minority of people may wish to never sell their business because they are building it as a family enterprise that they will pass on to their children, but for others, the sale of their businesses is critical to realising the fruits of their entrepreneurial and management efforts. The earlier business owners consider the realities of selling a business, the more likely they are to build a business that is actually saleable.

John Warrillow, the author of the book Built to Sell, reports that just one out of every one hundred business owners is successful in selling their business each year. The primary reasons that so many businesses are unsaleable is that (a) the business is too dependent on the current owner (b) the business offers nothing unique or distinguishable (c) the demand for the business offering is no longer growing or (d) the business is too messy because of poor records or potential liabilities.

How do you build a business that others will want to buy? In this article I will examine three phases of business value creation and what can be done within each phase to maximise the likelihood of a sale and the value that will be created through that sale. Phase one focuses on decisions and actions when launching the business, phase two focuses on decisions and actions when building a business, and phase three is orientated toward selling the business.

When building a business, it is important to begin with the end in mind. Therefore, if you wish to build a business you can sell one day, think about what will happen at the time of the sale. In discussing the key decisions and actions that are applicable at each phase of the business lifecycle, I will begin with the third phase and work my way back to the first phase.

Phase 3

Selling the Business

The most common buyer of a business is another business, but you may also sell your business to another individual or to public investors by listing it on the stock exchange. Because only a tiny minority — less than 0,1% — of entrepreneurs will ever list their firm on a stock exchange, I will focus on sales to other businesses or to individuals.

There are three major factors to be aware of when thinking about the sale of a business: (1) the reason for acquisition (2) the number of interested buyers and (3) the timing to sell.

Reasons for Acquisition

One of the keys to being effective in selling a business is to clearly understand why the buyer wants the business. There are four primary reasons why another company or individual will purchase a business: access to the cash flow and profits, access to the customer base, ownership of the technology in the business or utilisation of its people.

As a business owner, it is important to recognise what kind of value you are creating. Is your value embedded in the operating cash flow of the business, in its customer base, in the technology that is being developed or in the talented mix of employees.

Often a combination of these factors will be discussed in the sale negotiation, but in the end one of these factors will be the primary reason someone wants to buy your company. If you wish to sell your business one day, you need to create significant value in at least one of these areas.

One Buyer = No Buyer

A few years back I discussed the concept of exiting a business with Steve McCraken, a Seattle based serial entrepreneur who had

successfully sold three companies he founded. He told me that the number one piece of advice that he has learned through selling his businesses is that “one buyer is no buyer — unless you can create a bidding process between two or more interested acquirers you will very seldom be paid the true value of your business.”

Since hearing this I have observed it time and time again. Business owners who engineer more than one interested buyer get a much better deal when selling their business. Therefore, as you work toward selling your business make sure that you are keeping multiple potential acquirers interested in what you are doing.

Don’t Max Out: Sell on the Up

The third piece of advice related to selling a business is perhaps a little counterintuitive. Most people wish to sell their business when it is at the height of its popularity so they can show the best possible cash flows and profits; however, most people buy a business for its future prospects.

Therefore, it is generally better to sell a business while it is still growing; no one can forecast exactly how long business growth will last but the prospect of growth is much more attractive for a buyer than a company with stagnant or declining revenues.

The managers at Yahoo! have learned this the hard way. Over the years they have been offered less and less for the firm as revenues and profits have stagnated. Had they sold five years back, they would have made a much better return for shareholders than what they have by holding out.

If you plan to realise the value from your business by selling it, plan to sell before you reach the top of the growth cycle. Even if you leave some money on the table, you will be better off selling too early than selling too late.

Related: How To Expand Your Business To 5 Times Its Size In 5 Years

Phase 2

Building the Business

The value you create in selling a business will depend largely on the actions you take to build it. Therefore, if you wish to extract value by selling a business at some point in the future there are four key things you can do to build the business and make it more saleable and attractive to potential acquirers.

These include (1) systematising all processes and practices (2) reducing risk by eliminating dependency (3) keeping the records and liabilities clean and (4) incentivising people for the outcomes you desire.

Systematise Everything

The number one reason why business owners are unable to extract reasonable value from a business they have created is because the business is too dependent on them. If you are the business then the business is worthless without you. So how do you create a business that is not so dependent on you? The answer is through ‘systems and processes’.

Through the development of systems and processes you are able to create a machine that can operate when you are not there, a machine that can be replicated multiple times over, and that can be passed on to someone else who can continue to extract value.

In the insightful book entitled The E-Myth Revisited, Michael Gerber points out that it is no longer the hamburger that creates value for McDonalds, it is McDonalds’ systems. The more every element of the business is built into a documented, repeatable process that any person in the firm can carry out, the greater the opportunity to create ongoing value in the business, to expand it and to sell it when the time is right.

Reduce Risk

Many people refer to entrepreneurs as addictive risk takers. While good entrepreneurs invariably take risks to start and grow their businesses, they also aggressively manage risk to prevent avoidable failures. Bill Murphy Jr studied three Harvard graduates who, between them, started ten businesses.

In his book, The Intelligent Entrepreneur he reports that “successful entrepreneurs focus on managing their risks to the point where launching a new company is not much more risky than most of the other professional choices they could make.”

Risk while growing a business is related to dependency — the more you are dependent on someone or something the more risk there is in the business. People acquiring a business dislike risk and dependence. If they look at a potential acquisition and see a high dependence on one customer, one supplier or one employee they will immediately discount the value of the business.

Therefore if you wish to maximise the value of your business you need to spread your dependence across multiple stakeholders. Source your inputs from more than one supplier, diversify your customer base and spread responsibilities across a number of employees.

Keep it Clean

The sales of many businesses have fallen through because the buyers could not make head or tail of the financial records or because the sellers discovered an unexpected liability. In preparing to write this article I interviewed a number of business brokers and one of them said to me, “a clean financial history will inspire confidence and reduce the invitation for closer scrutiny… managers who use the right software, people and processes to keep up to date financial records make it much easier to build trust and negotiate with buyers.”

It is often essential to incur debt to grow a business, but outsiders hate buying debt. If you attempt to sell a business with significant or unexpected debt on the balance sheet, buyers will see it as a forced sale and believe they have the upper hand in the negotiation. Therefore if you envisage selling your business at a future date, work to clean up your balance sheet by reducing debt over time so that your finances paint an unambiguous picture for those interested in buying the business.

Incentivise Outcomes

One of the best items of practical management advice I was given by a professor while doing an MBA was: ‘What you measure is what you get.’ This can be expanded to: ‘What you measure and reward is what will drive people’s behaviour and the outcomes they achieve.’

This is a very important truth in building a business you can sell. If you reflect on why another business or person may buy your business — for cash flow, customers, technology or people, you can incentivise people to deliver based on the criteria that are going to drive the attractiveness and price of your business.

That means that if you are creating a social networking website that is dependent on a high number of users to make it attractive, the better you can incentivise employees to grow the user base, the more valuable your business becomes.

Related: How To Identify and Rescue Declining Products

Phase 1

Launching the Business

Research shows that a great deal of value is created or destroyed in a business based on the early decisions and choices that an entrepreneur makes. If you are launching a business as something more than just a hobby, clarity on (1) the competitive advantage (2) the scaleability and (3) the timeframes for building a business will help you make it more valuable over the long term.

Be Clear on Competitive Advantage

If your business is going to be worth anything to an acquirer one day, it should be able to do at least one thing better than anyone else. When starting a business many people are tempted into ‘me too’ businesses. Because they read that Mark Zuckerberg is worth $12 billion they think it must be a great idea to start a social networking website, something like Facebook.

Wrong! Facebook is valuable now because six years back the founders created a unique way for university students to connect. From the focused product targeted at a specific niche a global business evolved. Initially, Zuckerberg focused on doing a few things really well and that provided the firm with a competitive advantage in a specific area.

What you need to ask is, ‘What is my business going to do better than anyone else and for whom are we going to do it?’ If you launch your business with clear and compelling answers to those two questions then you are more likely to create a business that is worth something when you attempt to sell it.

Make is Scaleable

Scaleability is a term that comes from engineering but has become a very important concept in entrepreneurship. In engineering, scaleability is the ability of a system, network, or process, to handle growing amounts of work in a graceful manner or its ability to be enlarged to accommodate that growth. In business it refers to the ability of a firm to deliver more and more of its offering without placing significant or unreasonable demands on resources.

Scaleability enables growth. If it is difficult or expensive to sell more and more of your product or service to an expanding market, the lack of scaleability will limit growth which will ultimately limit the value of the business when you wish to sell it.

Factor in Timeframes

The final thing to be aware of when establishing a business is how long it takes to create one that is truly saleable. Although there are exceptions, the general rule of thumb is that most businesses take approximately seven years to reach a point of being sufficiently established to interest buyers. Therefore, if you are getting into business to make a quick buck, you may be fooling yourself. Building a saleable business is at least a seven year project.

Qualities of a Scaleable Product or Service

John Warrillow, the author of Built to Sell suggests that scaleable products and services exhibit three qualities:

  1. Repeatable. They are repeatable in that they don’t require a high level of expertise and customisation every time you make a sale and they are something customers need often
  2. Teachable. They are teachable in that you can teach employees to deliver so that you’re not the only person who can operate the business
  3. Valuable. They are broadly valuable so that more people will want them

Reasons a business gets acquired

  1. Cash flow: The most obvious reason for acquiring a business is to get access to the cash flow that the business is generating. The focus of the sale negotiation will be on the financial models underlying the company, the financial history, the forecasts and the risk attached to future cash flow.
  2. Customer: A second reason why a company is acquired is to give the acquirer access to the current and future customer base of the acquired business. Many web-based companies get good valuations when they are sold, even before they are profitable, because of their strong customer or user base. For example, AOL recently acquired the Huffington Post (a news website) and TechCrunch (a blog about technology start-up firms) for $330 million and $100 million respectively. Both of these firms have marginal profits but huge readerships which make them very attractive to larger corporations that believe they can monetise that reader base in the future.
  3. Technology: A third reason that a firm might be interested in acquiring another firm is to get access to the technology owned by the acquired firm. This is the reason why many pharmaceutical firms acquire biotechnology start-ups before their drugs have even been approved and the reason Google acquired YouTube for $1,5 billion just 30 months after the company was founded and before it was generating any revenue — they wanted the YouTube technology. Technology is most valuable when it is protected by patents and the value of such companies is often linked to the perceived value of the patents they have filed.
  4. People: A final reason why an acquiring firm may be interested in buying another company is to get access to the people in that company. Creative enterprises (eg advertising firms or design houses) tend to be acquired primarily to gain the talent of the individuals in the business. The challenge is that it is difficult to put a price on talent and people can walk out the door at any time. This is therefore the least valuable and most subjective reason for acquiring a firm.

Advice from Michael Gerber in The E-Myth Revisited

To truly systematise your business imagine making it the prototype for 5 000 more exactly like it. In so doing, you should strive to build a model that will:

  • Be operated by people with the lowest reasonable level of skill
  • Stand out as a place of impeccable order; it will operate in an orderly and repeatable fashion
  • Be rigorously documented in an operations manual
  • Provide a uniformly predictable service to the consumer
  • Keep operating when you or any other key individual is absent

Recommended Reading

Built to Sell: Creating a Business That Can Thrive Without You

  • Author: John Warrillow
  • Publisher: Portfolio Hardcover to be released on 28 April 2011

The E-Myth Revisited: Why Most Small Businesses Don’t Work and What to Do About It

  • Author: Michael Gerber
  • Publisher: HarperCollins; Third Edition (1995)

How to Build a Business and Sell It for Millions

  • Author: Jack Garson
  • Publisher: St Martin’s Press (2010)

High-growth, successful businesses are a result of a number of factors, none more so

than planning and beginning with the end in mind. This requires a thorough analysis and understanding of what your profit goal is, over what period of time you will grow your business and which reasons will motivate an individual or company to purchase your business: access to the cash flow and profits, access to the customer base, ownership of the technology in the business, or utilisation of its people. Consider this three phase approach to potentially and dramatically raise the sales value of your business.

Greg Fisher, PhD, is an Assistant Professor in the Management & Entrepreneurship Department at the Kelley School of Business, Indiana University. He teaches courses on Strategy, Entrepreneurship, and Turnaround Management. He has a PhD in Strategy and Entrepreneurship from the Foster School of Business at the University of Washington in Seattle and an MBA from the Gordon Institute of Business Science (GIBS). He is also a visiting lecturer at GIBS.

How to Guides

What To Measure To Make Sure Your Business Won’t Crash And Burn

Let your customers measure success for you and you’ll have a better idea of how to reach your goals.

Harry Welby-Cooke

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If you don’t want your business’s spurts of success to end up just a flash in the pan, you need to measure your business progress against your goals. This allows you to adjust your plans for future success accordingly. But how?

Back in the nineties, NASA designed an interplanetary weather satellite to orbit Mars. However, it deviated from its planned trajectory and was destroyed in the atmosphere, simply because of a minor miscalculation; a result of the NASA team and their contractor using different systems of measurement.

By the same token, business owners need to determine what metrics to use to measure their progress, before they can work out what still needs to be adjusted to get them to their ultimate goals. Many businesses know this, but many don’t know they’re doing it wrong.

Connect with your customers

Most organisations use the same key performance indicators such as sales, customer retention, and product quality to track their progress. What’s the problem with this picture? They’re measuring where they are now in relation to where they were before, leaving the question of where they want to be, and how to close the gap, to guesswork.

Related: Good Customer Service Is About Relating At The Same Level

Why waste time testing one strategy after another when you can find all your answers in one place: With your current and prospective customers? They’ll tell you exactly where to aim and what to do to get there. This is why customer surveys are the proverbial toolkit of business progress tracking.

A customer survey is simply a series of questions that you ask your customers, to gauge their satisfaction, so you can hold on to them and collect ideas about how to improve your business offerings.

There are a number of ways to distribute these surveys, but it’s no surprise that social media is trumping phone calls, text messages and emails as the preferred platform for customers to communicate with businesses and brands.

Engage with your customers

What you choose to ask your customers is entirely dependent on what goals you wish to outline and track. That’s the easy part, but it’s significantly harder to gauge the effectiveness of social media campaigns, because you need to know what to look for. You can measure awareness of your business using metrics including volume, reach, exposure and amplification.

Retweets, comments and replies will tell you how engaging your content is, and you can keep an eye on traffic by tracking URL shares, clicks and conversions. Plus, there is a plethora of additional plug-ins to this from ORM and sentiment tracking tools for deeper analysis of this data.

Related: Does Your Customer Service Care?

The catch is that in the past, businesses had to compete for space — on billboards, in magazines, during ad breaks on TV — but now it’s all about timing. So the first challenge is making sure your social media post questions are being seen by as many of your customers as possible.

On the flip side of the coin, people don’t have to have any previous experience with your brand to interact with you on social media, so another challenge is calculating which of your respondents are actually viable customers.

Leverage your data

You’ll need to tap into the analytics that speak to who your followers are, and then focus on finding ways of channelling them on social media, based on their geographical location and the kind of content they are most likely to consume.

Then test your social media measurements against your key performance indicators. Yes, we’re back where we started, but this time you’ll be armed with what you need to leverage this data, in order to achieve your business goals.

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How to Guides

How Do I Go About Valuing My Business?

Francois Otto, Head of Corporate Finance and Jonathan Wernick, Corporate Finance Transactor, Sasfin Capital give advice on how to value a business.

Sasfin

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Francois Otto, Head of Corporate Finance and Jonathan Wernick, Corporate Finance Transactor, Sasfin Capital give advice on how to value a business.

If you have ever thought about raising capital for, or selling, your business? Perhaps one of the most difficult questions you have had to ask yourself is “How much can I sell my business for?” Regardless of what anyone tells you, determining the value of your business is a subjective process.

The value of business in one person’s hands can be completely different to another. However, there are a variety of methods to determine the value of a business. Some methods are fairly simple and others are a bit more complex.

Perhaps the simplest method that can used to value your business is to determine its Net Asset Value (“NAV”). This simple method entails subtracting the value of the liabilities from the value of the assets.

Related: Raising Capital Through A Black Economic Empowerment Transaction

Another method that can be used to value a business is to apply a specific multiple to a financial metric. This method is referred to as a comparative valuation or “MULTIPLES” approach. For example, a company’s net profit could be multiplied by a specific number to give you a value of the business.

The number which you multiply the earnings by is referred to as a “Price Earnings” or “PE” multiple. The size of this number will depend on the business in question, for example its growth prospects, its size and the industry in which it operates, just to name a few.

The final approach that can be used to value a business is the discounted cash flow (“DCF”) method. This method adopts the philosophy of “Cash is King”.

Under this method, the business is valued using cash flows that the business is expected to generate. Cash flows can take the form of future dividend payments or, if the business pays a small or even no dividend, cash flows can take the form of profits generated by the business after adjusting for future capex, investments in working capital and taxes payable.

As this method values a business using the cash flows it is expected to generate in the future, a discount needs to be applied to these future cash flows (to reflect the uncertainty thereof), the size of which increases the further out in the future the cash flow occurs. The aggregate value or sum of these discounted cash flows represents the estimated value of the business.

Related: Here’s How To Value Your Business

The three valuation methods (NAV, MULTIPLES or DCF) mentioned above can yield different values for a business and deciding which method to use will often depend on the purpose of the valuation as well as the specific business being valued.

This exercise is normally the first step in raising capital or selling your business, to provide the owners with a sense of value. This value is theoretical until such time as a willing investor agrees to a transaction.

This is where a good adviser will assist the owners, through effectively marketing their business, to optimise the value achieved by the owners with the added benefit of ensuring the terms of a transaction are fair to the owners (e.g. reasonable earn-out conditions and warranties).

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How to Guides

How You Can Use Your Creditors To Fund Your Business Growth

Everything you need to know to keep your cash flow positive, use your creditors to fund your business, and make your numbers work for you.

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The success of a business is often judged by its rate of growth and its number of employees. The problem is that both a business’s rate of growth and its size come with their own demands and consequences, which are often ignored in the pursuit of more and more growth.

The reality is that not all growth is created equal. If your business doesn’t have scale, you can end up growing yourself into trouble — or even out of business.

Even more important is positive cash flow. Is that great new contract bringing in money, or costing you money? Shouldering an upfront cost for growth down the line is all part of the growth journey, but only if the numbers make sense and you know when your investment will turn to profit.

Here’s the secret to growth: It can be self-funded. Yes, there are venture capitalists, private equity firms, angel investors, bank funding and a host of other ways to access finance — but you can grow a large, successful organisation without any of these.

The trick is to know your numbers. Here’s how you can practically apply the rules of positive cash flow to your business.

Related: 6 Ways To Make Your Business Look Big While You’re Still Growing It

The Power of Cash

In 2012, Amazon’s share price was $173. By 2016 this had grown to $725. Walmart, arguably the biggest retailer in the world, went from $59 to $70 in the same period.

But take a look at Table 1 for the revenue growth of both companies between 2003 and 2012 (a trend that has continued).

revenue-growth

How can Walmart’s stock price have hardly increased, while Amazon experienced impressive growth over the same period, despite the fact that Walmart’s revenue growth far outstrips Amazon’s (in absolute, not percentage terms)? Is Walmart’s stock undervalued, and Amazon’s overvalued? Even accounting for growth off a low base, how can we explain this?

The share price is simply the net present value of future free cash flows generated from the efficiency of an organisation in managing cash to generate more sales.

In other words, Jeff Bezos’ focus on his cash conversion cycle has meant his business is incredibly cash-positive, which has in turn positively impacted Amazon’s stock price. Although Amazon is a highly unusual business with its negative cash conversion cycle, and its actual liquidity is somewhat contested by the investment community, it’s a great example of getting customers to fund growth.

Related: Five Keys To Unlock Massive Leaps In Profit

The Cash Conversion Cycle

We agree that it takes money to make money. A business, even one with a tight, scalable business model, will consume more cash in its growth phase than in its steady state, or execution phase.

But, you don’t want to ever spend more money than you need to — or can reasonably afford to. This is true whether you’re self-funded or spending someone else’s cash, but particularly if you’re funding your own growth. Dealing with unplanned funding can be costly, time-consuming and it hampers growth. It also bogs you down in stressful admin when you could be focused on the elements you love and that excite you.

There are two questions that you should have asked yourself as you embarked on your growth journey (note: if you’ve never asked these questions, you need to surround yourself with like-minded business people who can help you find and ask them):

  1. For what period of time is my money tied up in inventory and other current assets before customers pay for the end product or services?
  2. How much cash do I need to finance each unit of sale and what is the amount of cash generated by each unit of sale?

I guarantee you that Jeff Bezos knows the answers to these two questions. Not his accountant or financial director — Jeff himself. You can’t abdicate the numbers of your business to someone else. Understand the difference between delegation and abdication. You don’t need to be doing your business numbers but you absolutely need to know what they are. This is one of the most important metrics of your business.

Let’s go back to our example of Amazon (see Table 2): Bezos’ cash conversion cycle (measured in days), oscillates between -40 and -8 days. That’s the secret.

In other words, Amazon uses other people’s money to fund its operations. That’s an extremely valuable business model, as its share price demonstrates.

Walmart’s cash conversion cycle is also a very respectable 11 days. As a business model it’s not quite as valuable as Amazon’s, but there’s a reason why Walmart is an international leader in its industry. It takes this behemoth organisation just 11 days to convert $1 into something worth more than $1. It then recycles that original $1 a further 35 times per year. Walmart’s margins are not high, but the compound growth is very powerful, as we’ll see later.

Let’s Get Started

starting-to-fund-a-business

Step 1: Understand your business

To better understand the components of your operating cash cycle and your cash conversion cycle, take a look at Diagram 1.

cash-conversion-cycle

Operating cash cycle (OCC) is the period of time between when you start the assembly of all the required inputs into your production line, and cash comes back into the business as payment for the sale. Remember, if you’re a B2B business, there’ll be a delay between when the customer starts using your product and service, and when payment is made as well. This difference is referred to as accounts receivable days. Likewise the time between when your production starts (having received inventory) and the moment your business pays for this inventory, is the accounts payable days.

Cash conversion cycle (CCC) This is the period of time that working capital is tied up. It’s the time between when cash was converted into one of the inputs for your production line, and when the product is converted back into tangible cash, handed to you when customers pay you in real money. It’s the difference in time between your operating cash cycle and account payable days.

Self-financing growth rate (SFG)

This is the crux of this article. Your SFG rate is the rate at which growth can be sustained by cash generated by your business without any external funding.

Related: Why The Climb To The Top Is The Most Critical For Your Growth

Step 2: Working out your cash conversion cycle

Where can you access the figures you need to determine your own OCC, CCC and SFG? First, use data spanning a 12-month time period. This has two advantages: You have a better chance of sourcing accurate data if it comes from a signed off financial statement, and you can dampen the noise caused by seasonality.

Work with your balance sheet and income statement.

Working out conversion days from balance sheet

Asset ZAR amount on (000) Equivalent days Liabilities ZAR amount on (000) Equivalent days
Cash 10   Accounts payable 99 Calc A
Accounts receivable 384 Cal B Loan

repayments

50  
Inventory 263 Calc C Current liabilities 149  
Current assets 657   Retained earnings 183

 

 
Plant & equipment 25   Capital contributed 350  
Total assets 682   Total liabilities 682  

 

Working out conversion days from income statement

IS line ZAR amount on (000) Day equivalent Ratio
Line ZAR amount on (000) Day equivalent in (000) Ratios in %
Revenue / Income 2 000 = 2 000/365 = 5 479 100
Cost of sales 1   200 = 1 200/365 = 3 288 60
Profit 800   40
Operating expenses 700 = 700/365 = 1 918 35
NPBT – net profit before tax 100   5

income-statement-valuation

Based on the above example and figures, we have determined the following information:

  • This business generates R5 479 of income per day at a cost of R3 288 per day.
  • Calculation A: We owe a total of R99 000 to our suppliers, which at
    R3 288 per day is ~ 30 days from
    99 000 / 3 288
  • Calculation B: We are owed R384 000 from our customers, which at
    R5 479 per day is ~70 days from 384 000 / 5 479
  • Calculation C: The amount of inventory we have paid for and need to turn into a sold product in equivalent days is ~ 80 days from 263 000 / 3 288.

Our original ‘as-is’ timing diagram now looks like this:

cash-cycle-advice

We still need to account for operating expenses, including salaries, utilities, rent, marketing costs and so on, and we can safely assume (but check this for your business) that bills arrive uniformly over the 150 day OCC period, meaning some will be paid immediately (day 1) or have to wait (day 150). On average this is 75 days.

You should now interpret the information as follows;

  • The OCC is 150 days, but because the business has 30 days to pay its suppliers, the CCC is 120 days. In other words, cash is tied up for 120 out of 150 days (80% of the time).
  • In terms of operating expenses, we assumed a uniform distribution over the period whereby some creditors would be paid immediately and some would have to wait for the 150-day cycle to finish. On average, this leaves us with 75 days or 50% of the OCC.

Related: Mobility, Security And Your Business

Step 3: Unlock capital in your business

We now know for how long our cash is tied up, but we still need to determine how much is tied up. Using the ratios in the original income statement, we can now answer the following: What amount of cash is needed to finance each unit of sale, and what is the amount of cash generated by each unit of sale?

Cash conversion at work on your IS

Income statement line Per ZAR with CCC factoring effective per ZAR
Revenue/Income 1,00    
Cost of sales 0,60 80% (120/150) 0,48
Operating expense 0,35 50% (75/150) 0,18
Total costs 0,95 Cash tied up per 1 ZAR of Sales Revenue 0,66
Profit before tax 0,05
Free cash generated per ZAR of Sales 0,05 Cash needed for each OCC 0,66

Putting it all together

Let’s look at what you now know about your business:

Self-funded growth rate

The cash generated from 1 ZAR of sales By looking at the income statement ratio 0.05
The time in days of your OCC Calculated from holdings inventory days + accounts rec days 80 + 70 w= 150
The CCC time to cycle cash used in the OCC Calculated from OCC – accounts payable days 150 — 30 = 120
The cash tied up in each OCC for a 1 ZAR sales income Restated IS with CCC factored in for OpEx and inventory 0,18 + 0,48 = 0,66
Your per cycle growth rate Free cash that can be added to the OCC cash requirement 0,05 of 0,66 -7,57%
How many cycles can be completed in a year? Days in year available divided by OCC 365/150 = 2,43
Assume a productivity factor for safety 90% as a reasonable contingency for strikes etc 2,43 x 0.9 = 2,19
Compounded annual self-funded growth rate (1 + SFG) OCC cycles – 1) = (1 + 0,0757) 2.19 – 1 = 17,3%

Driving growth in your business

So, how can you use this information to drive growth in your business?

First, your debtors book must exceed your creditors book. Then, if we just shorten our accounts receivable days from 70 to 30 days, the following would happen:

  1. The OCC is now 150 — 40 = 110 days
  2. CCC is 110 — 30 = 80 days
  3. Cash needed for cost of sales is 0,60 X 80/110 = 43 cents
  4. We have not targeted operating costs yet, which remain at 18 cents
  5. Round everything up and we now need 62 cents instead of 66 cents (6% improvement)
  6. Your per cycle growth rate is 5 cents/62 cents = 8% growth rate
  7. How many cycles can you do in a year now? 365/110 = 3,3 cycles; up from 2,43!
  8. This is a 36% improvement
  9. Add a contingency of 95%, which gives us 3,13 cycles
  10. Compound this over a year: (1+ SFG) nbr of cycles — 1) = (1 +0,08) 3,1 -1) = 26% from 17% originally.

That’s 9% growth and nobody noticed a thing!

Related: Jason Goldberg Asks Are You (Realistically) Ready To Scale Your Business?


Key takeaways

  • That large corporate account that you cherish and that one of your sales executives is overly proud of landing may well be destroying value in your business. Why? Because large corporate accounts tend to get over-serviced (and I doubt you allocate those costs properly) and tend to pay you late.
  • Growing with a greater number of smaller customers, steadily over time, within your means and without being bullied delivers more value and less stress.
  • There are easy and clever ways to add lots of value to your business, that cost very little to implement, but you do require an understanding of how cash gets tied up.
  • Delegate, don’t abdicate. No entrepreneur is ever great at sales, production, operations and cash management, so get people who can complement your skill set, and allow you to do what you enjoy. That said, you can never hand the numbers over to someone else. Receive assistance if you need it, but know your numbers!

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