If you want to understand the actual value of your business and manage it effectively, understanding the cash flow is essential. It’s not just a buzzword—cash flow is a big determining factor of your business’s financial health. But with all the different terms out there, it can be tough to know where to start. But I’m here to help break it down for you.
EBITDA and SDE: The Basics of Cash Flow Evaluation
One of the most common terms you’ll hear when evaluating cash flow is EBITDA—earnings before interest, taxes, depreciation, and amortization. It’s a standard measure used to assess profitability, but for smaller businesses, another term comes into play: Seller’s Discretionary Earnings (SDE).
SDE is essentially EBITDA, plus the owner’s salary and benefits, giving a clearer picture of how much cash flow is available to the owner. This measure can be helpful for smaller businesses where the buyer is planning to step in and run the company.
Both EBITDA and SDE are valuable, but they only tell part of the story. Understanding cash flow requires looking beyond these numbers, and that’s where an experienced business advisor can help.
But the challenge is that these two measures are just one part of cash flow. Understanding your cash flow and you need an experienced business broker and advisor to help you sometimes work out the details and fine points of what cash flow really is to a sophisticated buyer.
Seeing the Bigger Picture
If you’re looking to sell your business down the road, potential buyers aren’t only going to look at one year of cash flow—they want to see the bigger picture. They want to look at what your long-term trends have been, whether they’re up or down, and whether there are one-time events that have impacted profitability.
For example, during COVID, so many businesses received PPP loans. Buyers wouldn’t count those funds when calculating earnings multiples because they want to see the business’s true performance.
Another critical aspect is capital expenditures. Let’s say your business generates a million dollars a year in EBITDA, but you need to invest half a million annually to maintain equipment.
In that case, your true cash flow is only half a million. Buyers need to understand this because it directly impacts the actual value of your business. It is important to understand this if you’re looking to sell a business.
The Impact of Working Capital on Cash Flow
Another factor to consider is working capital—something often overlooked. Working capital is about the cash you need to keep the business running smoothly.
If you need to pay suppliers in 15 or 30 days, but your customers pay you in 45 to 60 days, there’s a gap. You’ll need either a line of credit or extra cash to bridge that difference.
This issue is especially relevant for seasonal businesses. Landscaping companies or pool supply businesses, for example, often buy a lot of inventory at the start of the year to save on bulk purchases, but they don’t see cash from customers until later.
That’s a big working capital imbalance, and sophisticated buyers want to know how that impacts cash flow because it’s part of what they’ll need to finance.
More Than Just One Number for Valuation
If you’re using just one number to determine your business’s value—like a single year’s EBITDA or SDE—you’re missing the full picture. Buyers want to understand trends, capital expenditures, and working capital needs.
If you don’t have a complete understanding, you risk having the deal fall apart during due diligence. Buyers will uncover any gaps, and that could lead to them walking away or trying to lower the price.
Finding Someone for the Job
That’s why having someone on your side who knows what they’re doing is so important. An experienced advisor can help you understand the fine points of cash flow analysis, effectively present your business, and make sure you don’t run into problems down the road.
If you want to learn more about how to get your business ready for sale and fully understand your cash flow, feel free to book a call with me—I’d love to help you take the next step in selling your business with confidence!
