How to calculate surplus cash vs working capital ?

How to calculate surplus cash vs working capital ?

Many business owners allow cash to build up within their company over the years. Sometimes this is to keep their personal income tax below the higher thresholds if they do not need the income, sometimes it is to build cash reserves for a possible downturn. Within reason, surplus cash can also be added to the consideration paid for the company, allowing the business owner to benefit from BADR (Business Asset Disposal Relief – previously known as Entrepreneurs Relief) on the full amount, and therefore providing a tax efficient means of extracting the cash.

Whatever the reasons, how to determine what is surplus cash and what the company requires for working capital is often a source of debate in agreeing an offer with a prospective buyer.

Depending on the size of the company and the sophistication of its management accounts and cash flow forecasts, the buyer will look at various measures in the accounts.

Here are a few helpful tips for sellers to calculate and clearly prove to a buyer what is surplus cash:

1) Set-up a separate bank account

Set up a savings account (in the company’s name) into which you regularly transfer surplus earnings. It does not need to be exact, but you need to be sure to leave enough in the current account to pay for larger items which are paid quarterly or annually, such as rent, VAT or Corporation Tax. The aim is not to withdraw cash from this savings account other than for payments to shareholders’ such as dividends or pensions. This way, whatever the ebbs and flows in the current account, the surplus cash is clearly identifiable in the ‘savings’ account.

2) Keep a track of the bank balance

Whether you set-up a savings account or not, it is wise to keep a running tally of the company’s total bank balance each day for the last 12 months. You don’t need to check the bank balance every day as the bank statements will show the daily balance, but be sure to keep these records to hand in the run up to a sale, and list out for the buyer the large items and the usual dates these are paid during the year; again these are usually rent, VAT and Corporation Tax. This way, you can then forecast the cash balance going forward for the next 3 months and therefore the minimum level of surplus cash.

3) Prepare a cash flow forecast

Building on the above two disciplines, if you can present a forecast of the cashflow demands on the business, both in terms of money coming in and money going out for the next 3 months, this will show to all concerned, the minimum amount of cash which needs to be left in the company’s bank account(s) on completion. It will certainly ease the discussions in the run up to completing a sale. Better still, in preparing for a sale, start this discipline early; update your 3 month cashflow forecast on a monthly basis for the 12 months leading to a sale, so you can prove the accuracy of your forecasts.

As always, preparation is paramount, so do ask your accountant / bookkeeper for their help.

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