I wish this was my quote. But alas, it is from my friend Pablo Fernandez, Professor of Finance at the IESE Business School in Madrid, Spain and his forthcoming book “Valuation and Common Sense (4th ed.)”.
Remember, any company can show a profit and be bankrupt the next day if that day is the day they run out of cash.
Since most companies I deal with have values less than $10,000,000, I see many with iffy numbers on the balance sheet. Not that Fortune 1000 companies can’t have funky books too. Both accounts receivable and inventory that is overstated is a common problem. Or the numbers are stagnant and never change but once a year for the tax returns. As a provider of Business Valuations and M&A services (and with a background in Invoice Factoring & PO Funding), I always look at the details of both AR and Inventory with a jaundiced eye. As Ronald Reagan so articulately stated “trust but verify”. In the invoice factoring business the quote goes one step further “every invoice is fraudulent until proven otherwise”.
I say this as I read an article about a gentleman who stole $8 million from a company who also tried (thankfully unsuccessfully) to steal money from a factoring company I am associated with.
Spending time as an ABL (asset-based lender), you quickly realize that the weekly bills are relentless and the faster you grow the worse your working capital situation. You can’t spend inventory, accounts receivable, signed purchased orders or intellectual property; you can only spend cash from your bank account or from borrowing against these assets.
If you know anything about accounting one of the more fascinating facts is when sales go down, cash flow goes up and visa verse. Why is this? Well as sales go down, the bills go down and cash flow in from collections go up as AR goes down. Typically variable costs like direct labor and COGS are going down too as sales drop. Thus a short term burst in cash ensues.
My point is if you are buying a business, engage professionals who understand where the bodies are buried in the balance sheet. If you plan to sell your business, clean up the AR and inventory so the numbers don’t give potential buyers and their advisors and lenders pause.
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