Why Cash Flow Determines your Business Value - Not Revenue

Buyers Do Not Purchase Businesses – They Purchase Cash Flow

Buyers are not purchasing the past performance of your business; they want to purchase the future cash flow earnings of the business.

For this reason, most businesses are valued using the following to make this determination:

 Seller’s Discretionary Earnings (SDE) – for owner operated businesses

 EBITDA  – (Earnings Before Interest, Taxes, Depreciation, and Amortization) is a measure of a company’s operational profitability. Buyers often rely on EBITDA multiples as a benchmark for determining a business’s market value.

Both of these methods can be used to measure true cash flow but not accounting profit which is used to show financial health. Your business becomes more valuable when your cash flow is stronger, cleaner, and more predictable.

Knowledgeable buyers know SDE and EBITDA are just the beginning, not the final number.

In order to determine real value, buyers have to adjust earnings to evaluate what is actually available after the business takes what it needs.

Cash Flow Is What’s Left — Not What’s Reported

Even strong EBITDA or SDE does not automatically mean strong cash flow. Buyers dig deeper and ask:

• How much cash is tied up in working capital?
• How much must be reinvested in equipment and assets (CapEx)?
• How much of the cash flow will be lost to taxes?

These factors determine how much money a buyer can actually take home each year — and how much a lender is willing to finance.

Working Capital — The Cash Your Business Needs Just to Function

Working capital includes:

• Inventory
• Accounts receivable (money customers owe you)
• Less: unpaid bills
• 
  

A growing business often requires more working capital. That means cash is constantly tied up in daily operations.

A business can look profitable on paper but still consume cash because:

• Customers take longer to pay
• Inventory levels keep rising

To a buyer or lender, this means:
Part of the earnings cannot be used for debt payments or owner income — it must stay in the business.

This directly reduces:

• The loan amount a lender will approve
• The price a buyer can justify paying

Capital Expenditures (CapEx) — The Hidden Cost of Staying in Business

Capital expenditures include:

• Equipment replacements
• Vehicles
• Technology upgrades
• Major repairs

These expenses are not optional — they are required to maintain operations.

Many businesses show strong EBITDA but require constant reinvestment. Buyers adjust for this because:

Profit is not fully distributable if it must be reinvested.

The more a business depends on heavy reinvestment, the lower the true free cash flow — and the lower the valuation multiple.

Taxes — What the Buyer Actually Keeps

Buyers and lenders focus on after-tax cash flow, not accounting profit.

Even if a business generates strong operating cash flow, the buyer may lose a significant portion to:

• Income taxes
• Lack of depreciation or interest tax shields
• An inefficient ownership or deal structure

Lenders care because taxes reduce the cash available for debt payments, directly impacting financing approval.

Why Debt Coverage Ratio (DSCR) Drives Sales Price

Debt Service Coverage Ratio (DSCR) is a metric that lenders look at very closely.

DSCR answers a simple question. Does your business generate the cash needed to pay your debt with money left over?

The minimum DSCR that most lenders require is 1.25x. This means that for every $1.00 of debt payment the business must generate at least $1.25 in cash flow.

What many sellers don’t realize is that debt coverage sets a hard ceiling on what a buyer can pay. If your debt payment is more than your cash flow, no matter how great the business looks, the loan will not be approved. Simply put, no financing approval, no deal.

For this reason, the owner sells the business for much less than expected. Not because of the valuation, but because the cash flow could not support the asking price.

The Quality of Cash Is Just as Important as the Amount

Two businesses can sell for two very different prices even if they have identical cash flow. The determining factors that buyers and lenders pay close attention to are:

• Earnings consistency
• One time revenue vs recurring revenue
• Customer concentration
• Owner dependency and depth of involvement
• Financials that are clear, concise, and well documented

The higher the quality of cash flow, the lower the risk which would have a direct impact on valuation multiples (A shorthand way to express how much investors are willing to pay for a company).

How to Increase Your Sale Price Before You Sell

The best exits start about 12-24 months in advance by doing the following:

• Go through financials and start cleaning up statements and add-backs
• Start reducing unnecessary expenses
• Find ways to improve recurring revenue
• Begin restructuring or paying down debt
• Start reducing the reliance of owner involvement in the business
• Efficiently managing working capital
• Planning for future equipment and reinvestment needs

Final Takeaway

Revenue can tell you how big your business is, but cash flow can tell you how valuable it is.

When it comes to improving cash flow, small adjustments can make a big difference which can eventually unlock higher financing and have a significant impact on the final sale price and a successful exit.

If you are considering selling your business or have made the commitment to begin selling your business, please check out the blogs below for additional information.

10 Steps to Preparing Your Business for Sale

Positioning Your Business for Sale & The Scrutiny of Due Diligence

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