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How Free Cash Flow Impacts The Value of Your Business

Terry Mullen
Mar 30, 2017

There are plenty of reasons to keep regular tabs on the value of your financial planning or wealth management practice. If you're planning to sell the practice, you obviously need to know what it is worth, and calculating a fair market value will be an essential first step. But even if you have no plans to sell, knowing the fair market value of your practice can be a beacon for planning and management.

Calculating the fair market value of your practice can help you with your estate planning, making it easier for your heirs to avoid costly taxes in the future. A full understanding of the value of your practice can also make tax planning easier. Being able to envision how the value of the firm can actually grow over time can be quite reassuring.

Is Your Practice Your Most Valuable Asset?

Understanding the value of your firm can also make your own asset allocation much more transparent. Many practice owners put so much time and effort into building their businesses that they neglect other parts of their investment portfolio. As a result, their practices end up being the most valuable assets they own, and that can leave them in a dangerously unbalanced position.

Using in-house research tools and outside services like Truelytics can help practice owners see where their businesses stand in an impartial way. Once they know how much of their net worth is tied up in the practice, they can work on diversifying their holdings and building a better asset allocation model going forward.

Understanding Free Cash Flow Analysis

Understanding how free cash flow impacts the value of a financial planning business is essential. It's a vital first step when considering a sale, developing an estate plan or assessing your asset allocation.

In the past, financial practice owners often valued their firms by multiplying their non-recurring revenues by a set amount, but that method of valuation is no longer the most accurate way to value a business. Increased competition in the financial industry has often resulted in lower revenues, while expenses have remained consistent or gone up.

A Better Way to Balance Your Business

That means that free cash flow is generally a better way to provide a fair market value for a modern financial planning or wealth management practice, and the amount of free cash flow can have a profound impact on the resale value of the business.

Whether you're valuating the practice in anticipation of a future sale or calculating its value for purposes of estate planning or asset allocation, determining the free cash flow is a good first step. Any buyer will want to see the free cash flow history of the firm, so having that information at your fingertips will be invaluable.

The Value of External Help

If you need help calculating the free cash flow generated by the practice, among other business metrics, you can use a service like Truelytics. Or if you're comfortable doing this analysis on your own, you can grab your profit and loss statements, balance sheets and other documents and get going.

Once you know where you stand and how much free cash flow your financial practice is generating, you can start to build a solid valuation model. In doing so, it will be helpful to understand how a potential buyer will look at the numbers, and how they might be used in sale negotiations.

See Your Practice Through the Eyes of a Potential Buyer

When a potential buyer looks at your free cash flow history, they will use the numbers to form assumptions, not only about the current profitability of the firm, but also about its potential future growth rate, its margins and expenses, and its worth going forward.

A potential buyer is also likely to consider some intangibles. You should build such soft factors into the valuation model you create. They may be difficult to valuate, but have a profound impact on the operation of the practice post-sale, and on how the new buyer values the practice going forward.

Intangible Elements

Any serious buyer will try to quantify intangible elements and add them to the free cash flow analysis you have created. They will look at things like client retention data and the average AUM for each client. They will also review client satisfaction data and try to predict how clients might behave in a post-sale environment.

Potential buyers will also look at things like employee morale, using it to gauge the likelihood that your top performers will stay with the firm after the transfer of ownership. These intangible elements can have a huge impact on the true value of the firm, over and above the free cash flow analysis you have already performed.

Valuing your financial planning or wealth management practice is not an easy undertaking, but performing a free cash flow analysis is always a good place to start. Whether you perform it on your own or apply a service like Truelytics, knowing how much cash your practice generates is an essential first step when preparing for a sale, adjusting your personal asset allocation or performing estate planning for your heirs.

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