How to Project Cash Flow When Doing a Deal?

I hate subjectivity and guesswork. Business analytics is the art of trying to take the guesswork out of any important business decision where a great deal of money is at stake. Nowhere is this more evident than on the buy-side of an M&A transaction. The subjectivity, variance and chances for mistakes remain very high. And, the most important aspect of the valuation you perform for the business are the assumptions you make and the cash-flow you project. That cash flow, while subjective, will be the basis for determining what you’d be willing to spend in an acquisition scenario. What follows below are some detailed questions worth asking to determine potential cash flow in your assessment of the acquisition of a business. Keep in mind, many of the answers are subjective and qualitative and will still require a basis and assumptions to equate them to an income statement.

  • What are the projections provided by internal management? Are the projections they’ve given reasonable? What assumptions were made in the drafting of said assumptions?
  • When looking to the future, does the company have a good track record of meeting management cash flow projections in the past?
  • What does the industry look like? Is it growing? Is it in decline? How does the target look vis-a-vis the other competing firms in the industry? In other words, does the company have a secure and competitive position in their market niche? Are there barriers to entry to ensure at least the status quo? Nothing is worse than a significant decrease in cash flow after a buy.
  • How cyclical are the cash flows? If they’re not steady, how will your analysis take this into consideration?
  • How does management expect the company to grow? What assumptions are included in their growth expectations?
  • What are the working capital and fixed asset requirements for implementing management’s growth plans?
  • If the business is seasonal, what working and fixed capital is needed during peak times of the year? How will this effect cash flow?
  • Not that you could predict them, but what macro and micro events may play a role in cash flow? (could include competition, foreign competition, strikes, loss of suppliers, currency fluctuations or a whole host of other issues)
  • Are there assets, divisions, subsidiaries or other units that should be sold to improve efficiency? If sales of such assets or subs were made, how long would they take, how much money would they net and how would the money be reinvested?
  • What are–if any–other sources of cash from the business?
  • What are all the areas in which the deal could go very wrong? In thinking through the details of this question, does current management have contingency plans in place in the event that worst-case scenarios are played-out to the max?

While my list here is far from being exhaustive, it should be a good reflection of some of the qualitative areas which will need to be assessed before a deal is finalized. Assessing “real” cash flow can take hours or up to weeks, depending on how “real” the numbers are and how correctly they reflect the true performance of the company. For the LBO buyer in particular, it will also be desperately needed to know how much cash will be needed at closing and for the working capital requirements for years to come.

It’s unfortunate that most deals are difficult to find and when the good deals are found, the numbers may not reflect the true value of the cash flow.

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Nate Nead
Nate Nead is a licensed investment banker and Principal at Deal Capital Partners, LLC which includes InvestmentBank.com and Crowdfund.co. Nate works works with middle-market corporate clients looking to acquire, sell, divest or raise growth capital from qualified buyers and institutional investors. He is the chief evangelist of the company's growing digital investment banking platform. Reliance Worldwide Investments, LLC a member of FINRA and SIPC and registered with the SEC and MSRB. Nate resides in Seattle, Washington.