I am often asked by business owners how to generate additional cash, beyond what their own company’s cash requirements are, to make an acquisition, expand into new territories, hire additional staff or buy a new plant and equipment. All of these growth scenarios take significant cash. Since many companies have existing debt, their borrowing capacity is often limited. Therefore, generating additional cash strengthens a company’s balance sheet permitting the company to increase its credit facility.
In today’s environment, whether you’re borrowing money for an acquisition or for growth and expansion, lenders and sellers are vetting operating companies’ and buyers’ capacities to repay loans — particularly if an acquisition is structured with an earn-out or includes seller financing as part of the deal structure. Therefore, when needing to borrow funds for any growth and expansion plan, or acquisition, the credit-worthiness of the operating company or buyer, respectively, is critical. Generating additional cash, whenever an owner can, is important since a company’s cash requirements are generally extensive. The more cash the owner can bring to the table, the less the owner will have to borrow.
Before developing a strategic borrowing plan, I advise clients to first examine the full potential of cash sources existing within their own companies. The most obvious place to look for internal cash generation is the current asset section of the company’s balance sheet. In many companies, generating cash from existing assets is often overlooked.
The conversion of under-utilized assets to cash provides a triple bonus. First, when needing to borrow funds, it reduces the amount of the funds needed; second, it improves the balance sheet, thus improving debt coverage ratios; and third, at the very least, it improves cash flow.
If an owner examines each element of his current assets, receivables can offer substantial opportunities for generating additional cash. For example, if a company with $25 million of annual revenues shortens its average receivable collection period by only two days, it will produce almost $150,000 of additional cash. Also, changing sales terms, or tightening credit standards, procedures and follow-up, often can improve the average collection period by as much as a week. If that $25 million company, for example, reduces its collection period by a week, then as much as $500,000 of interest-free cash can be added to the company coffers. Regardless of the company’s size, shortening the collection period to as few days as possible will generate significantly better cash flow and additional cash.
Analyzing inventory is another resource often overlooked. In addition to the obvious tactic of reducing gross inventory levels, there are often more subtle elements which can be explored. Three questions owners should ask themselves are: 1) Are there product lines which contribute nominal amounts of sales, but which absorb significant inventory resources? 2) Are there inventory items which are in small demand but are required to produce low volume products with high margins? and 3) Are there suppliers that can be induced to assume some inventory functions (Just-In-Time for example), even though it may require entering into annual supply contracts?
Examining inventory levels and usage in this way will have a salutary effect on improving the balance sheet, as well as generating additional cash.
Finally, another place to find additional cash is examining the fixed asset accounts on the balance sheet. In addition to the obvious tactic of outright disposition of assets (excess land, unused/underutilized equipment and similar items), there are opportunities to sell and then rent or lease back such items as vehicles, computers and plant and equipment. While these arrangements can be more costly than owning, it is worth examining them as another source of cash.
Since many of our clients are looking for acquisitions or to sell their companies, I advise those looking to buy companies to use these and other techniques to find “synergies” which can lower their acquisition costs and add additional cash to the acquired company’s operations. All of these techniques should be examined during the due-diligence process of any acquisition or expansion.
After the owner has squeezed every last nickel of cash out of the various balance sheet items, it’s time to develop a strategic borrowing plan. Start with the owner’s cash flow statement. The historical cash flow of a company is the surest prediction of how much money can be borrowed solely on the strength of the company’s own resources.
Regardless of your needs for generating additional cash, whether it be for profit improvement, growth and expansion or acquisitions, a review of your asset utilization — particularly receivables, inventory and fixed assets – will provide opportunities to generate additional cash, improve the balance sheet and P&L statement, and lower borrowing needs.
Gary Miller is managing director, Consulting Division, SDR Ventures, Inc., a Denver-based investment banking firm. He specializes in strategic business planning, M&A advisory, exit strategy consulting and post integration services. Reach him at 720-221-9220 or firstname.lastname@example.org.