Hi there everyone it is David Barnett and this week I am answering a question from Bruce and Bruce asks: What are the best businesses to buy with respect to cash flow? Now as far as my understanding of what cash flow means is I want a business where a high percentage of the sales ends up down in my pocket. So, there is really three categories of businesses as far as I am concerned that can create a high degree of cash flow.
The first sector is what we will call regulated businesses; now when you first think about regulated businesses you might think about larger businesses like: power utilities or natural gas pipelines for instance. Anywhere, where rules and regulations prevent new competitors from entering the market. This can be good for protecting the profitability of the players that are already there. Now, in some jurisdictions there are some regulated industries that would be considered small businesses that you could get into. Where I live for instance it is highly regulated who can be in the bottle return business, so there is only a certain number of a licences out there. And what that does is it limits the competition for each region of the providence meaning that the operator who has the licence can probably get a little bit more profit out of that business than he would be able to if there were many competing businesses all around him, so that is the regulated industries.
The second category would be your service businesses where you don't have a high cost of goods sold. So this would be in contrast to a business where you sell goods; let’s say I sell oil I take in a dollar of sales I might have to take $0.90 of that dollar and turn around and use it to buy my product. So, that is a commodity business, I wouldn't consider that a high cash flowing business. If you compare that to a service like house cleaning, you may have a labour component but you can adjust your labour input to meet demand, to meet the sales. So if you don't have work and you don't have homes to clean you then cut back on the hours that you employ your employees so that you can have more of your sales fall through to the bottom line. And that is why there is such a huge service sector in the industry and I even consider things like restaurants to be part of the service sector. Because, they tend to have a low cost of goods sold. if you can meet that breakeven point every month. Then a high percentage of your marginal sales over break even ends up down in the net income one.
The third category of businesses that would be a high cash flowing sort of business to get into would be a business that you work once but get paid many times. So, think about for example the books that I write; each one of them took days of my time and effort to write and then edit and then prepare them. But now that they are done I can sell them over and over again and every time I sell them I earn money but I don't have to do any work. That is why we see such crazy sky high valuations in the world of IT or online businesses. There is a term in the online world called "SaaS" or software as a service. Where they take what might have been years ago a piece of software that you would buy but instead of selling you the software they put it online and they let you use it for a monthly fee. There are all kinds of things on there now that you can probably find that can be offered as software as a service like accounting packages and things like this. Even google apps like google docs if you are business; you can sign up I think, I believe it is only $5 per month per user.
But if you consider the fact that the work gets done once and is now out there on the internet and now serve thousands or tens of thousands or millions of people with the same platform then obviously all these customers that come in are creating more work for the people that built the system. Now that it has been built it is up there it is running, so those are your three categories; regulated businesses, service business and call it technology or intellectual property businesses where you create or do something once and are able to sell it many times over.
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