In order for your business to be successful and ultimately sale ready, we take a look at what you need to do to ensure you are in the box seat at all times. Knowing where your capital is tied up in your business goes way beyond the balance sheet.
According to the Australian Bureau of Statistics, only 4% of registered businesses ever make it to $1 million in turnover. One of the fundamental reasons a business will fail is that the business owner does not appreciate how much capital they have invested.
Not understanding how much equity is in your business can be a road block to growth and profitability. Not knowing exactly what invested capital is owned by the bank can lead to repayment schedules that can also inhibit growth. It is not until it’s too late that these tight schedules are questioned. When the business needs more cash or assets, the bank says yes to another overdraft or another lease and then sets a schedule that restricts excess cash being able to be reinvested in growth.
This merry-go-round not only happens to start-ups but also to established businesses that are already profitable. With an explanation from your accountant, banks are usually willing to relax their schedules however, it is ultimately the responsibility of the business owner to understand their finances beyond the balance sheet. A profit and loss statement won’t show how much cash is being swallowed up by the mismanagement of working capital.
As a business grows it can be tempting to take the money out, but without investment the percentage of turnover needed for working capital keeps on increasing. This also leads to a gap between the revenue and profit. At this point you risk damaging the value of your business. You can have two businesses side by side with the same profit but it is the business that converts this profit more efficiently into free cash flow that will always be worth more.
Rob Ashley, a private client’s principal from PwC, has developed ten financial rules that business owners should follow in order to maximise the value of their business.
- Revenue must exceed costs, unless you’re pursuing a hobby or charity instead of a business.
- Know how much capital you have invested.
- Know how much you own of the capital.
- Know the limit of your borrowing.
- Know what returns you are getting on your investment.
- Know if you are creating wealth or destroying value.
- Know how much working capital you should have to run your business.
- Know if you are generating positive free cash flow.
- Know when to take cash out of the business and when not to.
- Measure and improve your economic denominator.
Your economic denominator is one thing that you could pick in your business to systematically increase over time. It should be something that will have the greatest impact on your bottom line and it must be sustainable. An example of an economic denominator in a retail environment is profit per customer visit.
If you would like help to determine your economic denominator or want to know more about making sure your business is sale ready at any given moment, then please give us a call.