Cash Flow Forecasting: The Ultimate Reality Check in Your Exit Plan

As you prepare to transition out of your business, it is imperative that you secure an accurate future cash flow model.

Why is the Future Cash Flow Model so Important?

  1. In a sale to employees, co-owners or children, cash flow may be the sole source of payments to you. These inside buyers may not have enough money of their own to pay you. Without significant planning and implementation, inside buyers may not be able to quickly acquire or borrow that cash.
  2. If you choose instead to sell to a third party, the valuation of your company is likely to be based on a multiple of cash flow.
  3. Should you plan to sell part or all of your business beginning in 2013, your CPA should make cash flow projections for 2013 through 2017.
  4. If you are preparing your own cash flow projection, resist the temptation to create an overly-optimistic forecast. To avoid this temptation, owners usually ask their CFOs or CPAs to create these forecasts.
  5. With a realistic cash flow projection in hand, you can begin to plan the most tax-effective way possible to achieve that future cash flow.
  6. Remember! The future cash flow of the business may be your buyer’s only source of funds to pay you, particularly in the early years. If under new ownership, the company cannot achieve the cash flow numbers you project, you may not receive the expected payoff.

The only exceptions for not needing a cash flow model are either liquidation or in some cases, a gift of the company to your children.

How to Use the Cash Flow Forecast
Determining the net after-tax distribution to you is the goal of this exercise.

  • Step One is forecasting cash flow
  • Step Two is to calculate how that cash flow will be allocated during the ownership transition.

To do so, you must calculate, for each year of your exit plan period, the expected available cash flow reduced by:

  1. Reasonable compensation to you, and
  2. The cash the company must retain for growth, working capital, etc.

The remaining cash flow is distributed to the shareholders, you, and—to the extent you have sold part of your company—the new owners.

New owners use that distributed cash to pay you for shares of ownership. If the projected cash flow to new owners is insufficient to pay you through an installment note, your exit is at best temporary.

Since Cash Flow is Core of an Exit Plan, How do you Increase Cash Flow and Use it Wisely?

A successful Exit Plan minimizes taxes for both seller and buyer and keeps sellers in control (and minimizes their risk) until they receive full value for their ownership. All plans begin with an informed understanding of current and future cash flow and require considerable planning and action to achieve these goals.

Your Exit Plan is founded upon your exit objectives  – when you want to leave, how much money you want and need, and who should own the business after you –  and upon the likely future cash flow of the business. Forecasting the amount of cash flow and determining how that cash flow is used is, indeed, the ultimate reality check for your business exit.