What drives a business to its ultimate success? Not EBITDA. Anna found that out four days after she decided to retire. Anna had spent forty years building Growth. She had three children and three grandchildren, two of them living abroad, and she had started to think about how often she might see them. Not one week a year. Properly. The five-year figures had just landed on her desk, and they were the best in the company's history. Revenue had more than doubled, from £7 million to £15 million. EBITDA was up 67%. Net profit had more than tripled. Every headline number had risen, every single year.
She called Chris, her chief executive. "Chris — a beautiful five years. Thank you for these results. You know I have been thinking about retiring for a while. It's time for us to find an investor who can carry this business on and look after our people." "Anna, I completely understand. After forty years you have earned it. Let me start some conversations. Valuation is a long and tedious process, but I'm confident we'll get you a meaningful exit." Chris found Tom, his finance director, in the office the next morning. "Tom — Anna wants to sell. On your five-year report we've grown revenue, EBITDA and net profit every year. But how is our cash position, for the purposes of a valuation?" "Tell me what she's expecting first." "Twenty million. Two million of EBITDA, times ten. Ten years of earnings, paid to her up front." Chris paused. "Private equity is active. They'll be interested if the numbers stack up." Tom did not answer straight away. "Chris, I want that number for her as much as you do. But I'd rather flag this now than have her disappointed later. Our cash has never been as good as our EBITDA. I've raised it at every board meeting since Year 3." "And?" "We generated cash in the first three years. Not in the last two. Let me do this properly. Give me a day." Tom called Maya, the group treasurer, as soon as he left Chris's office. "Maya — I need a five-year cash report. How much cash this business actually generated, Year 1 to Year 5. And I want the most generous version you can honestly defend. Every pound of cash we brought in, including interest and hedging." "You want it to look good?" "I want it to look as good as it can while still being true. If the number doesn't work on the best case we can honestly put forward, nobody can accuse me of being pessimistic." Maya spent the day in five years of cash data. Her report landed in Tom's inbox that evening. Hi Tom, Here are the five years. I've included every pound of cash we generated, as you asked — operations, interest and hedging. In total cash terms we were positive in four years out of five. Only Year 5 is negative. One thing I should flag: our cash from operations went negative in Year 4 as well, and was lifted back out of the red by interest income and hedging gains. Maya
Tom read it the next morning. Maya was right, and the picture was not as ugly as he had feared. Four positive years out of five. Only the last year in the red on both measures. Then he did the piece Maya had not been asked for. Cash from operations is not what an owner gets to keep. The business has to replace what it uses, and it has to pay its tax. Neither of those is Anna's money. Take them out, and what remains is owner earnings — the cash the business actually generates for whoever owns it. He asked Chris for thirty minutes that afternoon. "This is our cash performance for five years. We generated positive total cash in four of them, as Maya said. But our cash from operations and our owner earnings were both negative in the last two." "How bad?" "Year 3 turned seven hundred thousand pounds of profit into fifty thousand pounds of owner cash. Years 4 and 5 turned profit into nothing at all — they went backwards. Across five years, owner earnings are negative one point four million."
"Chris, I don't think this supports twenty million." Chris looked at the page for a long moment. "Understood. But revenue's doubled and profit's tripled, Tom. That's a growth story. Let's put it in front of them and see what they say." Chris sent the financials across. Tom attached his own analysis and said nothing more. The response came back four days later. We like this business. The growth is real and the profit is real, and we would be glad to put a value on a company like yours. But the revenue and profit growth has not converted into cash. On our numbers, investable owner earnings were negative in each of the last three years. Specifically, we cannot underwrite the interest income or the hedging gains. They are real cash — we do not dispute that. They depend on interest rates and on currency markets, and Growth controls neither. We will not pay a multiple for a rate. For the avoidance of doubt, we have found nothing your finance director had not already found. We are simply not willing to pay for a rate and a currency move. Over five years you reported three point three million of profit. On our numbers the business consumed three point three million of the owner's cash. A pound out for every pound reported. To be clear, this is not a question of price. We are not negotiating the twenty million you asked for. On these numbers we cannot arrive at a number at all. If the cash converts, come back to us.
They took four days. Growth had five years. Chris called Anna as soon as he had read it. "Anna. This is disappointing news, and I'm sorry. They like the business. They like the growth. But not this year. Our profit isn't converting into cash, and until it does they can't put a value on us." There was a pause on the line. "So not this year. I've told the children. Tom knew, didn't he?" "Tom told me three weeks ago. He's been telling the board for three years. I thought the growth story would carry it." Anna did not say anything for a while. "What would it take, Chris?" "I'm going to ask Tom." Tom's answer was shorter than anyone expected. "Four things, and none of them are complicated. We recognise revenue we never invoice. There is four and a half million pounds of work sitting on our balance sheet that we have never billed anybody for. We bill it, or we stop calling it revenue. We invoice work we never collect. That's two point seven million. We are holding three million of supplier payments to flatter our cash position. That isn't working capital. It's borrowing from people who didn't agree to lend to us. And we count income we cannot repeat. Interest and hedging gains kept us looking positive for a year after the trade had stopped working. They bought us a year we hadn't earned. None of that needs a valuation expert. It needs one number, once a month. How much of the profit we reported became cash we could keep." He paused. "I'll never present owner earnings that way again." This is the third reason I created SLOS. Part 5 asked where the cash came from. Part 6 asked why profit never became cash. This one is about what happens when somebody else asks those questions — with a chequebook, and no obligation to be kind. Here is what Growth learned, four days too late. Cash survival is not the same as business success. A business can pay its bills every month for five years and still be worth nothing to a buyer, because surviving and being fundable are different tests. What a buyer pays for is cash that is repeatable and investable. Repeatable means it happens again next year. Not a disposal. Not a currency movement. Not a rate. Something the business produces because of what it does, and can produce again. Investable means somebody else will fund it. They will put their own money behind it, because they can rely on it arriving. Most founders optimise for a third thing entirely — reported profit — and reported profit requires neither. And the hardest part is this. Growth's buyer did not bring a better method. They did not find anything Tom had not found. They ran the same arithmetic on the same figures, and applied one stricter definition, because it was their money. Tom could have run that test himself. So could Anna. It takes one ratio, calculated from accounts they already had, once a year for five years: For every £1 of profit we reported, how much became cash that was ours to keep — and that we could rely on keeping again? Year 1: £1.00. Year 2: £0.80. Year 3: minus £0.43. Year 4: minus £1.50. Year 5: minus £2.50. Five numbers. Available every year. Nobody was obliged to look at them, so nobody did. That is what a standard is for. Not to produce a report after the fact, but to make the question unavoidable — every month, before anyone offers to buy anything, and long before a buyer makes it unavoidable for you. Anna will get her exit. The business is real, the customers are real, and the work Tom described is entirely fixable. She just won't be getting it this year. And she had already told the children. If you're building towards an exit — or you simply want to know what your business would be worth if somebody asked today — I'd like to hear how you measure it. Comment, or send me a message. Mala Sun — Founder of Stonerose Treasury