Acquisitions Anonymous - #1 for business buying, selling and operating - How to Not Run Out of Cash in Your Business? - e63

Starting point is 00:00:00 All right. Welcome to Acquisitions Anonymous. Today is the first and hopefully first of many new formats that we're trying this year, which is conversations around how-to topics that we repeatedly hear over and over again on social media. I am your host, Michael Gurdley. I am here with Bill Delessandro and special guest and all-around badass Mitchell Baldridge, who is a CPA and all-round cool guy that we know from Twitter and other parts beyond. And today we wanted to dig into one of the things we hear about over and over again, which is I'm buying a business. How do I make sure that after I own it, I don't run out of money?

Starting point is 00:00:40 And there's all kinds of things that get thrown around, EBIT, net operating income, free cash flow from operations, EBIT, and all those things kind of tie back together to, I've got this thing, and how do I make sure that I'm not going to be in big trouble if cash flow gets wonky or I run out of money or any of those kind of things. So yeah, so you guys own a business, you just bought it. How do you make sure you don't run out of money? Yeah, I think this is a stew question because the future version of this question is, I've run out of money. Why? Right. So at least the asker here sees it coming. Yeah. Or at the, the, and thank you all for having me back, by the way. Or at the, you know, day after closing when they realized that there's

Starting point is 00:01:30 no working capital in the business and that, you know, there is a cash flow cycle that's going to take longer than, you know, the next 17 days of, you know, two payrolls that no one ever thought about when they were buying the business. So, yeah. What is a cash flow cycle? Like, if, if there's people who they don't teach that in college. Like what is it? I guess that's, how long does it take to prospect, sell, deliver,

Starting point is 00:02:06 and receive cash for the product you're selling? And what is your general administrative costs related to that sale over that amount of time? And then what are the hard costs of what you're actually delivering through that amount of time? and how long is it going to take to generate your gross profit and net profit, right? Yeah, dig it. So if I'm trying to put together a picture of what all that is, like, what are the tools in my arsenal? So, like, there's like a budget. There's my bank statements.

Starting point is 00:02:43 Like, what are the things I should be looking at as a small business owner to say, okay, these are the tools I can deploy to solve this kind of problem of, I don't want to run out of money and call dad or mom. Or worse, grandma. You don't want to call grandma. Then you know things are bad. Always call grandma first. She just ruined Thanksgiving.

Starting point is 00:03:03 So, I mean, I think what this so often comes down to is that people tend to run their business on the income statement when they really should run the business on the cash flow statement. Because, I mean, I have, as a short personal anecdote, I almost bankrupted my business in 2015 because I did not do this. Wait, you say they run it on the income statement. They run it out of their checking account. Well, that's even worse.

Starting point is 00:03:28 So the income statement's a good business, right? But, sorry. So, for example, so at the time I was running a sunscreen brand, a very seasonal, high working cap, right? So we would have to order months in advance before summer. And then if we didn't sell through, we'd just have to sit on it for, you know, six months until it would sell again. And the end of every, and the business was growing. So the end of every year, I was like, the P&L says I made money, but my bank balance is lower.

Starting point is 00:04:00 Like, what is going on? And it was because all of that cash was sitting on the shelf in inventory. Because as we were growing, we were having to buy more and more inventory, and it was sucking cash. So even though the income statement said that net income was plenty positive, if I looked at a cash flow statement, it would have been. then seeing cash out the door for a growth in inventory balance. So, you know, kind of my, at the very top level, I think it's learning the difference

Starting point is 00:04:29 between an income statement and a cash flow statement. Yeah. And I mean, also, I think it was the, who was it, the Home Depot founder, his book, I forget the book name. Someone's yelling at me right now. But, you know, everyone's looking at this figure called EBITDA, but what does EBITDA mean when you actually do have to pay depreciation because you have to go buy new equipment at some point, whether you use a loan or not, and you do have to pay taxes. So why are we looking at businesses and throwing out depreciation and throwing out amortization and throwing out taxes when they are real expenses?

Starting point is 00:05:14 And if you bought a business, the interest is real expense as well. You know, as is the amortization of your principal is real money out the door. So, yeah, so you're, yeah, you go, okay, well, I am making this force savings of this amortization of my principal, but it doesn't help me buy more sunscreen. And yeah, the interest is going straight out the door. And I depreciated this forklift. And, yeah, I have a five-year note, but in five years, I'm going to need a new forklift. or however long this equipment lasts,

Starting point is 00:05:50 it's, it's, you can't just disregard it and throw it out the window. And then beyond that, I, and I tweeted this a while back, but a lot of people think they're really smart right now because of ERC, PPP, EIDL, there's been so much government stimulus that's just cramined, thinking through that people think they made money and they didn't make money. They got bailed out, essentially. Yep. Let's talk about a couple things. Let's talk about the common things that bridge between like an EBIT dot number. So if you buy a business, I mean, podcasts, Acquisitions Anonymous, people are trying to buy businesses, right? A business is typically,

Starting point is 00:06:42 if you're buying it, they're going to report to you an EBIT dot number, typically, as Mitchell said. EBIDDA for the non-accounting inclined is earnings before interest, taxes, depreciation, and amortization. So it basically means you start with net income and then you add back those things. You also add back a whole bunch of adjustments if your broker is worth their salt, which you need to question in the... Your son's gas card. Yeah. Including everything from boats to country clubs, memberships, etc.

Starting point is 00:07:13 But so obviously there is taxes, right? We all got to pay taxes. most LLCs have to make a tax distribution every year to all of their members at the highest tax bracket. So right there, and that's, by the way, not going to show up, you know, on your EBITDA at all. So you've got kind of 40% of net income, which is going out the door in the form of taxes, which can be especially brutal if you might not have the cash because you might have plowed it all into working capital, which we're going to get to in a little bit. So I've seen a lot of businesses struggle to even pay their taxes,

Starting point is 00:07:47 because they have plowed all the money back into inventory. There's also interest there. So if you bought a business with debt, you're going to be paying interest, which is not an EBITDA. Then there is depreciation and amortization. Again, for the non-accounting inclined. Depreciation is usually an accounting treatment where you bleed off the value of physical assets over their useful life, whereas amortization is the same concept but for intangible assets.

Starting point is 00:08:13 Broadly, Mitchell, please don't skewer me if those definitions are not exactly correct. That's about right. But generally, so those are generally non-cash expenses. So you don't have to pay those out of your pocket, but they are indicators that your forklift, as Mitchell alluded to earlier, is getting crappier and crappier every year and we'll buy about that much money and will eventually need to be replaced. So Scoopad Mills isn't here because he's always the one that pounds the table on the capital assets with this business are garbage.

Starting point is 00:08:44 You're going to have to replace all the trucks in five years and it's going to cost a million dollars and it's not in the financials. Well, the same thing even exists in real estate where people talk about bonus depreciation in real estate and how great it is. But meanwhile, every 10 years, you're going to have to go rehab all those apartments if you want to keep a new roof or whatever it is, right? Yeah. So there is a benefit to all the depreciation and amortization, which becomes you're much more

Starting point is 00:09:12 bankable than intangible businesses. So banks like it when you have things they could go find that they can touch and they figure they can resell because they have residual value. So equipment, real estate buildings, furniture, fixtures, all that stuff is things that then allow you another tool that you can use if cash flow gets lumpy on you, which is lines of credit, right? So you can go to a bank and you can say, hey, here's my balance sheet for my business. This is me.

Starting point is 00:09:44 Here's my personal balance sheet. and then you're able to say, hey, we're going to make a million dollars this year in terms of profit. Can we have a line of credit for $500,000? And the bank may ask you to, sometimes the bank will say, yes, congratulations, here's your line of credit. More likely they will say, hello, small-time entrepreneur. We would like you to personally guarantee this so that we know we're going to get paid back unless you declare bankruptcy and then we're still going to come up to your assets. So that is one of the tools you can use to bridge this stuff. And I am involved in businesses that are asset light and still have lumpy cash flow.

Starting point is 00:10:18 And we have lines of credit there to help bridge that out. And with today's interest rates, it can be a pretty good deal. Yep. I always tell business owners that the kind of the two things you use debt for are the first one that you just mentioned, Michael, which is to smooth out lumpy operations. And also to finance assets that can be used as collateral that tend to grow as your business grows. So if you're an inventory-based business, and you need to buy more and more and more and more machines, more and more trucks, more and more, any kind of physical asset that your business requires as it grows, that is, that asset is collateral a bank will loan against.

Starting point is 00:11:00 So you should typically be looking to deploy debt capital to help you scale into those assets rather than equity capital. It pains me so often, especially in my business, consumer products, where I see these scaling brands, and they raise $5 million because they don't have any cash, and they basically just use the money to buy inventory, which when they could have just easily gone to get a line of credit. There's also in businesses that are low asset, but have recurring revenue, things like pipe out there, or basically new revenue. factoring tools that will, or factoring being, we're going to give you your revenue up front, or we're going to give you a credit line based on what we know essentially you're going to bill and collect over the next X days so that you can, yeah, use debt rather than equity to finance your ongoing growth. Hey, everybody.

Starting point is 00:12:06 Michael here. We have an advertiser for today's podcast. It's the David C. Barnett, small business and dealmaking and M&A podcast. So David is the distinction of our number one Canadian sponsor. And it's a podcast all for people who are interested in buying, selling, financing, and managing small and medium-sized businesses. And he focuses on a lot of really, I think great tactical and strategic issues here. Buying in an industry when you don't have any experience, broker commission when there's a seller note and all that kind of stuff. So thanks to David for supporting the episode today.

Starting point is 00:12:46 And so David is doing a special deal for our listeners. You can get a free copy of this book, 21 stupid things people do when trying to buy a business. And you can download that when you go to the link in our show notes. And it's on his Gumroad site. where he has some stuff around that. And so check that link below. And thanks again to David and his podcast for sponsoring our podcast and our never-ending quest

Starting point is 00:13:12 to break even. So have a great day. I have been in business a while. This is the easiest credit market I've ever seen for small businesses or for small-scale assets since the Great Recession. We don't have the no-no mortgages right now, but we do have the, oh, congratulations. Did you like to borrow money for 10 years? It's 3.5% amortizing.

Starting point is 00:13:35 Thank you very much, 80% loan to value. Well, that's the SBA, though, right? I mean, that's not even the market. That's the distortion, right? That's not as... We just did a deal last week of borrowing money at that rate for land. Curious. How big was the deal?

Starting point is 00:13:51 It was just over seven figures. So a million and a half a second. You got to notice me, you're a banker. That is phenomenal. Well, you know, when you're... I saw the bird monster. they roll out the red carpet. He can walk into any bank in San Antonio, get that deal.

Starting point is 00:14:08 Texas is a hugely competitive lending market. It's kind of like everybody wants to deploy their capital in Austin multifamily right now. Every bank wants to be huge in Texas. So it's very competitive. I've heard the 10-year interest-only jumbo home mortgage is a hot ticket item that I've heard of lately. So essentially a lot of people are, yeah, I mean, we're talking about business cash flow statements, but if you're a small business owner, you also have to globally step back and loop your personal life into your business balance sheet and go, okay, well, I have this cash in my business, but I have this, you know, a million dollar 10 year I owe home mortgage that's going to balloon in 10 years. presumably that hopefully I can refinance out of. But like, you then have to loop your personal balance sheet into your business and

Starting point is 00:15:08 understand what, what is the opportunity cost of what debt do you have personally or what deferred maintenance do you own personally or what assets do you have that you're not really even considering? You know, when you're a small business, it's all one thing. Yeah. Well, and I would say there's an asterisk. on that, like the cheapest money you can borrow right now, like it always is a home mortgage. Like, there's a school of thought that if you're, before you take on business debt, you should be

Starting point is 00:15:40 taking on home mortgage debt. That stuff's going to be super duper cheap. I have a home mortgage. That's a great deal. Yeah. It's the way it should be. I think you have to be really insane on the income well-scaled to not have one. Anyway, it's just cheap, cheap, easy money.

Starting point is 00:15:59 So I would say that's one thing where you're right. You want to build up assets in your personal life and make sure that's not going to be a ding against your business when you go to borrow there if you need to. But how much do you pull out of your business every month out of your business cash flow to live your personal life? Because if you can just roll the whole thing forward, you can compound your business a lot faster than if you have to pull out $37,000 a month to live your life. You know, it's just, it's a give and take there. 37,000. How do you live on 37,000? What are you, not in New York?

Starting point is 00:16:35 What are you buying with 37,000? I have no idea. I don't even know what I could spend that much money on. Like, what do you buy in layhouse? Remember the $200,000 nanny? I remember, uh, most of that with that one. That was like four Twitter meme cycles ago. I can't even keep up.

Starting point is 00:16:56 Good memory, Mitchell. So what metrics you guys prefer then? So, I mean, for the question of measuring, is my business generating cash, once you're an operator, what metrics do you guys use or what tools do you guys use? For me, like I, for, and for all the business I've involved in, there's two major tools, right? There's a cash flow model, which is I want to see, okay, what is your cash flow going to look like week after week, month after month, month, quarter after quarter after quarter. through the year, and that needs to tie back to what their pro forma budget is for the coming year, right? And so I can say, okay, well, you know, it's really easy for a CEO. Most CEOs are very growth-oriented. They say, okay, this year I'm going to do $2 million in revenue. Well, like, break that down

Starting point is 00:17:42 for me. I want to see a cash flow model of what's going to look like each quarter because it does mean no good if your cash flow model shows me that you're going to burn $6 million through the year and then do $8 million on one night at the end of the year. By the way, I just described the fireworks business, too. So it's really hard. Anyway, and then, and so that's a much worse business than one that's generating every week cash over cash over cash and it's deerous that way. So those are the two tools like I'm going to want to see. And so it's much easier said and done. That's the second point about that. I know businesses that are $40 million top line that have trouble generating a quarterly cash flow model for years. Like it is because there's so many things moving.

Starting point is 00:18:26 So that's where I think it's like super important as a small business person. Like you need to have your annual plan for the year, which is your budget and your pro forma of what you expect stuff to look like. And then you need to build a cash flow model. Like how much cash am I burning or am I growing in terms of what I have each individual week? Because you want to start doing that when your business is small, not when you're at 30 million and $5 million in profit. And you have to say, hello, CFO. Welcome to your first day of job. I need all of this stuff.

Starting point is 00:18:53 So we don't go bankrupt and problems get really big at that point. So those are my two big tools. Just if you go in, if you've been running your business for the last five years and you plan to run it five more years, if you go into your quick books and you print out one thing I love looking at just even in my business is print out your balance sheet, your profit and loss and your statement of cash flows and print them out over a 13 month period or a 12 month period and print out the monthly view. columns and just watch how your money fluctuates. Watch how your top line revenue changes. Watch how your salaries change. Watch how your cost of goods or whatever your input changes. And then do the same thing on your cash flow statement. Watch how money goes in. Watch how profits get made. Watch how money goes out. And you'll learn a lot about your business cycle or you'll learn a lot about last year at least. And then you'll be able to do more of what Gerdley's talking about,

Starting point is 00:20:01 which is, well, what is next year going to look like? I know I had this top line revenue goal. Well, what's going to happen to the input? Well, what's going to happen to the GNA? Well, am I going to have to go borrow money? I had to borrow. You know, if I didn't get this $150,000 dollar EIDL loan last year, I would have lost money. I thought I made money. You know, I mean, you start to realize the real honest inputs of where your money is coming in from and how profitable you are just if everything was stripped out of your business. I love the idea of printing out the balance sheet month to month to month because that's, I think,

Starting point is 00:20:48 would get so many people on it from a cash flow point of view is that variations in the balance sheet accounts impact your cash. As your inventory grows, that sucks cash. As your accounts receivable grows, that sucks cash because you're floating your customers, right? You recognize revenue, but you didn't bring the cash in. As your accounts payable grows or your credit card balances, generates cash, right? So understanding the puts and takes the cash flow that are balance sheet generated, I think is what so many people miss. And by doing that monthly, like you talked about, Mitchell, I think it'll let people see it month to month. Yeah. And you're either doing the fireworks business model or the sunscreen model of gearing up, gearing up, gearing up, all year. And then,

Starting point is 00:21:32 you know, you have this huge sale event and then you have whatever's left and then you have to gear up again. There's other businesses that actually effectively work in reverse. Nathan Barry was talking about how they, every year, do this big year-end sale and he gets most of his income on one day for ConvertKit, where everyone re-ups. And then that's all deferred revenue, which sounds like the best business in the world, but you even have to manage that. We just got our huge chunk of revenue for this year all on one day. And now we have to manage cash through the rest of the year. And we have to grow new customers through the rest of the year. how do we do that? You operate those two businesses very differently from a cash management standpoint. One of them is probably a better problem than the other, but nonetheless, they're both problems. Negative cash conversion cycles. It's the hottest thing. You can read wherever you want on the internet. I'll stick with that phrase. Well, cool. I think we've done good. One thing I wanted to add when I thought about this topic, and I'll give you guys a chance to say that before we close, but

Starting point is 00:22:42 like I think going to this issue of your cash management and how do you make sure you don't run out of cash, it comes back to this issue of how do you think about making your business anti-fragile, right? And so for me, like, all businesses die because they run out of cash. Like, that's just the way it works. And so for me, whenever I have something, like, I want to make sure, like, there's a plan A, a plan B, a plan C, and a plan D that I know I can go through all those options to make sure that there's always money in the banana stand, right? Like, that's how I'm going to go out to, if you're, that's an arrested development reference

Starting point is 00:23:18 if you guys aren't Gen Xers. So I'll give you a clip notes. But like, okay, number one, like, you know, am I going to make sure like there's enough money in the company and that's plan A, okay, plan B, we're going to have a line of credit in case I need it. Okay, plan C, like I'm going to know that I can call a relative, like grandma. And if grandma doesn't work out, then I know I can go sell equity. and I know there's these five people I would call,

Starting point is 00:23:41 like that is going to be my way. I'm going to make sure like bankruptcy is not an option because I have these five different ways I figured out how to make my business anti-fragile, but I'm planning on never getting past a plan A, which is make sure like we don't run out of cash. So we, it was slugher this way. In early 2020, when the shit was hit the fan,

Starting point is 00:24:05 we were glad we already had lines of credit in place. Yeah. Because when you need the money, no one wants to put a line of credit in place. Go get it now. Totally. All right. Awesome job, guys. We'll click send on this one.

Starting point is 00:24:20 And we'll catch y'all next time.

Acquisitions Anonymous - #1 for business buying, selling and operating - How to Not Run Out of Cash in Your Business? - e63

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