Author Michael Podolny at Google+

Valuing a Small Business-

Transferring Ownership to Financial Independence

Common Sense Strategies for Valuing a Small Business Higher

How Using Free Cash Flow Translates to Financial Independence (Part 4 of 4)

We’re finishing up our discussion of earning a good return on investment on our businesses and having that contribute to our ability to achieve personal financial freedom.  In the last post I discussed how the overall equity value of the business could be used to achieve those goals.  In this post, I will be showing how taking out a portion of the cash/profits produced each year by the business and investing them can greatly increase an owner’s return on investment.

Why is this?  It’s because this strategy is additive to the overall equity strategy not an alternative to it.  It is like getting twice the value from the same investment.  Let’s look at the variables that need to be considered for this strategy to work.

For income distribution to contribute to personal financial freedom, it must be done on a consistent basis and those proceeds must be actually be saved and invested.  Therefore these variables need to be accounted for:

• Owners must distribute money on a consistent annual basis and have the discipline to save and accumulate those funds
• A rate that can be safely distributed must be calculated after accounting for taxes and necessary reinvestment in the business
• An intelligent, conservative, consistent investment strategy to produce a compounding effect on the proceeds
• The period over which the funds will be accumulated
• The amount that can be earned off the accumulated funds
• The taxes on the income that is earned on the accumulated funds
• The desire and rate at which one would access and spend the actual proceeds themselves

Let’s look at an example of how this strategy would work out using the same business base assumptions we used for the example last week.  That assumption was your business has an average annual cash flow of $500,000 per year. Let’s do our calculation over a 10-year period with no growth in cash flow taking place over that period to be very conservative.

We are going to further assume that you 30% of your cash flow each year is available after taxes and reinvesting in your business.  That cash flow is going to earn 5% a year and be reinvested to create a compounding effect.  Finally when we are ready to sell the business we’ll invest the proceeds that have accumulated at 5% and pay a 25% tax rate on that income.

Annual cash flow from our business = $500,000

Annual cash flow invested = $150,000

Total accumulated after 10 Years with compounding = $1,886,682

The income earned on the accumulated savings = $94,334

The taxes on the income earned = $23,584

The after-tax cash to support your personal life style = $70,751

Now look at what this has done for your financial independence. Your annual after-tax cash to support personal lifestyle from the sale of the business was $70,313.  To that we now add the $70,751 from your long-term savings program for a total of $141,064, a doubling of your return on investment applied to financial independence!

This shows you the power of this strategy.  Of course no one has the same cash flow year in and year out.  But if you make cash flow distribution one of the primary goals of your business and build your strategy around it, you will be amazed and the amounts you can generate, distribute and accumulated.

But this is not all.  In my next post I’m going to show you yet another tool for driving your return on investment and financial independence up yet another notch.

Author Michael Podolny at Google+

Valuing a Small Business- Transferring Ownership to Financial Independence

Common Sense Strategies for Valuing a Small Business Higher

How Building Equity Translates to Financial Independence (Part 3 of 4)

We’ve been talking about a core goal of most business owners, earning a good return on their investment and having that contribute to their ability to achieve personal financial freedom.  We discussed that there are two ways of achieving a return on investment in a small, privately held business.  One can increase the overall equity value of the business and one can take a portion of the cash/profits produced each year by the business out and invest them.  These are not mutually exclusive.  In this post I will focus on how to use the underlying equity value of the business for contributing to personal financial independence.

For the value of the business’ equity to contribute to personal financial freedom there must be a mechanism for selling one’s equity, meaning that equity has to be turned into cash that can be invested in other assets.  This can be done via either an internal market (a succession/internal transaction) or the having the business sold to a third party. In calculating the ability of an equity sale to produce financial freedom, a number of variables need to be accounted for:

• The actual value that can be realized in an actual transaction (as opposed to the theoretical value from a valuation)
• The taxes that would be paid on the realized value
• The income that can be earned on the after-tax proceeds
• The taxes on the income that is earned on the proceeds
• The desire and rate at which one would access and spend the actual proceeds themselves

Here is a very simple example of how this might play out.  Let’s assume you have a business that has an average annual cash flow of $500,000 per year, that you can sell that business for 5 times its cash flow in an all cash transaction, that you will pay taxes of 25% on the proceeds of that transaction, that you can earn 5% on the proceeds, you have a 25% tax rate on that income, and you only want to use the income earned on the proceeds to fund your financial independence.

Transaction proceeds = $2,500,000

Taxes on the proceeds = $625,000

Net after tax proceeds that can be invested = $1,875,000

The income earned on the after tax proceeds = $93,750

The taxes on the income earned = $23,437

The after-tax cash to support your personal life style = $70,313

As you can see there are a lot of variables that need to be considered.  In addition to these other variables would be how much will you get from Social Security and when will you get them, do you have other assets, or do you have a retirement plan that you’ve been contributing to.

The key for you the business owner is to understand these variables and include them in your planning.  Forewarned is forearmed.  If you can do these analyses on your own so much the better.  But don’t be afraid to get help if you need it.  An owner can greatly increase their ability to increase their return on investment and achievement of financial independence just by understanding and slowly beginning to manage for these variables.

Author Michael Podolny at Google+

Valuing a Small Business-

Transferring Ownership to Financial Independence

Common Sense Strategies for Valuing a Small Business Higher

Understanding What’s Needed (Part 1 of 4)

Why does anyone make an investment? Presumably because they want to make money.  When one becomes a business owner, that person is making an investment.  Most business owners expect their investment to increase in value.  They tend to focus on the potential value increase as a primary benefit that should come from the investment.  They don’t always think about the income an investment could be spinning off – but they should.  The income producing capability of an investment is a major component to evaluating an investment.  Let’s call these concepts of increasing value and income produced from the investment Return on Investment.

Further, most business owners come a point in there life where they hope to not have to work, to be able to live on and enjoy the fruits of the investment into their business.  This means having a means to produce income that does not require working.  Let’s call this concept Financial Independence.

Return on Investment and Financial Independence are not the same things.  I can have a very nice return on my investment but if I don’t do certain things I won’t be able to achieve financial independence.  But the opposite is not the case.  It is highly unlikely as a business owner that I can achieve financial independence without getting a good return on my investment.   So an adequate return on investment is necessary for achieving financial independence but does not guarantee financial independence

In this series of blogs, I’m going to be discussing specific strategies you can use to ensure that you focus on return on investment and convert it into financial independence.  We’ll start by reviewing the heart and soul of value creation, profitability and cash flow.  Then we will look at the specific means one can use to convert that value to financial independence.