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Sunday, 30 April 2006 17:00

Smart shop owners and jobbers watch cash as much as sales

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For anyone in this industry who started out hustling sales - whether that means collision repair jobs, cans of paint or tools and equipment - pulling back from a focus on growth in gross sales can be a challenge. Increasing the top line, after all, is often a key ingredient in increasing the bottom line. More sales equals more profit, right? 

Tracking "days of receivables"

Want to make sure that in your quest for new sales you're not letting payment for your current sales lag dangerously behind? Tracking your accounts receivable "by days" can help you make sure you keep the cash flow you need to succeed and grow.

Take your accounts receivable (charged sales) for a month and multiply it by 12 and divide by 365. The result equals "one day of receivables." Divide your current total receivables by this daily amount to find out how many days of receivables you are owed.

Say your monthly sales last month were $100,000. Multiply by 12 and divide by 365 to get roughly $3,287. If your total accounts receivable are now $131,480, you have "40 days of receivables" ($131,480 divided by $3,287).

Want to control that number? Set up a monthly and quarterly bonus system for those in the office responsible for accounts receivable. For every month and quarter the days of receivables stays at or below the number set (35 days, for example), they get a bonus - and you get the money owed to you that you need to keep the business growing.

 

But in an industry with over-capacity - too many jobbers, too many shops - growth often requires acquisition: entry into new markets, or purchase of competitors in existing markets. That kind of growth requires cash and a different although not altogether new way of monitoring your business' finances.

Joe Mattos, for one, is a solid advocate of a cash-centric form of financial management.

"Cash is cash; everything else is just a journal entry," says Mattos, a third generation CEO of Mattos Pro Finishes, a 78-year-old paint distribution company now with 17 branches in five states. "We need to be managing our businesses to focus in on cash. You can look at all the numbers, and generate all kinds of statements. But when it all comes down to it, all that accounting is just the way you write down numbers. When you boil it all down, what really matters is cash."

His reasoning? In a jobber or repairer market that has too much capacity, your business needs to generating the cash you need to grow in a consolidating industry - or the cash that will drive up the value of your business when you sell.

"So you have to be on one end or the other. You either need to grow, or you're going to sell," Mattos said. "Either way, you want to be focusing on cash."

And whether you're buying up a competitor or selling to one, Mattos said, you need to understand how to determine the value of your business or theirs - again, a function of the cash the business generates.

The two key numbers

CPA Jeff Whipple has been managing Mattos Pro Finishes' numbers as the company's chief financial

 

 Year-End EBITDA Statement for ABC Paint and Body Supply

 

 Sales

 
 
 
 
 
$3,400,000
minus
 
Cost of Sales
$2,150,000
equals
 
GROSS PROFIT
$1,250,000
   
Payroll and Benefits
$721,000
plus
 
Rent/Occupancy Costs
$126,000
plus
 
Other Operating Costs
*$247,000
equals
 
TOTAL OPERATING COSTS:
$1,094,000
   
Gross Profit
$1,250,000
minus
 
Total Operating Costs
$1,094,000
equals
 

EBITDA

*Should not include depreciation, amortization or interest expense.

$156,000
 
 
 
 

officer for about a decade. He said that measuring and tracking two numbers will help a business focus on cash.

The first goes by the acronym EBITDA: earnings before interest, (income) taxes, depreciation and amortization. The second is "free cash flow," essentially what you have left aside from your working capital (inventory plus accounts receivable minus accounts payable) and investments in long-term assets (vehicles, computers, equipment, etc.).

"The value of your company is going to be a function of the free cash flow," Whipple said.

Start by generating your own EBITDA statement for each of the past two or three years. You can draw the numbers from your regular financial statements because it's really just a different way of looking at the same numbers.

Chart 1 shows a sample for the fictional ABC Paint and Body Supply Co. Whipple cautions that business owners may need to adjust the "payroll and benefits" figure from their financial statements for the EBITDA statement based on how much they are paying themselves.

If times have been tight and you've cut or eliminated your salary, you may need to add to this figure to accurately reflect what someone else would need to pay someone to manage the business or do the functions you perform in the business. Similarly, if times have been good and your pay reflects bonuses or other "rewards" you have taken based on your investment risk in the business, this figure should be reduced downward, again to accurately reflect just the amount a non-owner would receive to perform the management or other functions you handle.

You can check the accuracy of your EBITDA statement by adding up your interest, depreciation and amortization expenses. This amount added to your EBITDA should be the net income shown on your regular financial statement.

Now that you know your EBITDA, it's time to determine where that earnings has gone. First, it's gone into working capital. Again, your working capital is defined as the value of your inventory plus your accounts receivable minus accounts payable. Whipple recommends determining this number at a given point to serve as a baseline, and then track it year to year. The change in that number is essentially money you've given back to customers or vendors, Whipple said, whether that's in terms of increased inventory, money owed or money owed to you.

{mospagebreak} 

EBITDA After Working Capital for ABC Paint and Body Supply Co.

  2004 2005
Accounts Receivable
$303,000
$344,000
plus    
Inventory
$449,000
$478,000
minus    
Accounts Payable
$207,000
$215,000
equals    
TOTAL WORKING CAPITAL
$545,000
$607,000
   
(change:
$62,000)
     
EBITDA  
$156,000
minus    
Change in
Total Working Capital
 
$62,000
equals    
EBITDA AFTER WC  
$94,000
minus    
Long-Term Investments  
$40,000
equals    
FREE CASH FLOW  
$54,000
 
 

EBITDA after working capital

In the example of ABC Paint and Body Supply (see Chart 2), the company had a year-to-year increase of working capital of $62,000. Deduct that from its EBITDA and you end up with $94,000 (EBITDA after working capital). Whipple said this number is a good one for any business to track, because it essentially represents what the business can spend on long-term assets or other investments.

"If you've ever heard about a business growing too fast and going bankrupt, it's because they didn't track this number," Whipple said. "They were growing their top line by doubling their sales, for example, but their inventory and accounts receivable went up dramatically, and suddenly their EBITDA after WC was negative. You do that one or two years in a row, and suddenly you can't afford that vehicle or other long-term assets you need without adding a lot of debt service."

Next, add up what you spent for the year on such long-term assets: vehicles, computers, furniture, phone systems, equipment and - in the case of many jobbers - "customer investments." For the purpose of this analysis, treat all such purchases as if they were made with cash, even if you actually financed them.

ABC Paint and Body Supply (see Chart 2) spent $40,000 last year on such long-term assets. Deduct this from its $94,000 EBITDA after working capital to get the company's "free cash flow" of $54,000.

"What that represents is cash that could be 'freely' returned to the equity owners without affecting the business," Whipple said. "This free cash flow can be either a distribution back to the owner - or is available for any debt service, for the interest and principal. And don't forget that your other partner, Uncle Sam, also gets paid out of this."

Tracking provides future benefits

Tracking EBIDTA, EBITDA after WC and "free cash flow" over a period of several years will help you in a number of ways, Whipple and Mattos said. It will help you determine what kind of investments and purchases you can make - and which ones should be made using cash rather than financing. It will help you stay on top of accounts receivable

"And since the value of your business is based on a multiple of your EBITDA, tracking and improving this number makes your business more valuable," Mattos said. "It also helps you understand what another business you are thinking about purchasing is really worth."

By communicating the information from the above calculations to everyone in management, you can help prevent bad decisions that jeopardize the company's financial performance.

"Since we started tracking this some years ago, our EBITDA has almost quadrupled, even though our sales have only doubled," Mattos said.

That, he said, helps ensure his business has the cash it needs to remain a growing player in a consolidating industry.

John Yoswick is a freelance writer based in Portland, Oregon, who has been writing about the automotive industry since 1988.

 

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