Profits play a key role in building the value of a business. However, there are numerous other value drivers that can have an impact. Individually, these value drivers may have little effect, but when added together they can have a significant positive or negative impact to the overall value and attractiveness of a business when placed for sale.
From buyer’s perspective value drivers are the characteristics that reduce the risk of owning the business and/or increase the probability that the business will grow in the future. The most common value drivers include: Management Team, Systems & Procedures, Customers & Suppliers, Facilities & Equipment, Financial Discipline and Growth Strategy. If these characteristics are present in your business, a buyer will pay a premium price.
Too many business owners make the mistake of retaining complete control, which makes it hard to separate them from the business. Additionally, a Management Team comprised of any number of family members is a concern to buyers. Start now to designate a manager or assemble a management team that is capable of running the business now and after your departure.
Systems & Procedures
Like the management team, reliable systems and well documented procedures will help sustain the growth of a business and ensure a smooth transition to a new owner. Write a formal business plan; create written job descriptions; develop a systems manual; organize customer and supplier files; consider investing in technology and software tools that will help streamline current procedures.
Customers & Suppliers
A diversified customer and supplier base helps to insulate a company from the loss of a single customer or dominant supplier. No one customer should account for more than 10-20% of your total sales. This may require you to invest in additional capacity that will allow you to broaden your customer base. Taking the time to investigate your current suppliers is a prudent strategy and may result in reducing your cost of goods as well as your reliance on a major supplier.
Facilities & Equipment
Make sure your facilities are up to code and convey the image you want to project. Invest in new equipment and maintain service records.
All businesses are valued based on the health of their historical income statements as well as 5-year projections that are substantiated. The existence of financial controls supports an owner’s profitability claims. It is extremely important that your company’s financial records are accurate and verifiable. A potential buyer or lender will want to carefully review them.
Being able to demonstrate a realistic growth strategy is vital to the perceived value of your business. Creating a pro forma statement with projected discretionary earnings is the best way to communicate future opportunities. Make sure you document your assumptions and clearly outline new products, marketing efforts, increased demand, industry dynamics and other factors that impact growth.
If the value of your business proves insufficient to support your long-term financial objectives, you should devote a significant effort toward focusing on the key value drivers and the necessary action steps to build value. If the valuation is right in line with your expectations, you should take steps to preserve its value and occasionally have the business re-valued. Industry dynamics and the health of the economy are external factors that can greatly alter the market value of your business.
For Additional Value Growth Opportunities Perform a SWOT Analysis
To perform a business analysis, start by conducting a SWOT (Strengths-Weaknesses-Opportunities-Threats) analysis. Identify the company’s true strengths, known weaknesses, growth opportunities and any threats to the future of the firm. Strengths and weaknesses are internal factors. Opportunities and threats are external factors.
For example, strengths could be a new, innovative product or service, the location of your business, or your marketing expertise. A weakness could be undifferentiated products or services, or a damaged reputation. Opportunities could be a developing market, such as the Internet, or a strategic alliance. A threat could be a new competitor in your home market, price wars, or legislative action that negatively impacts your industry. Make sure you are realistic and very specific when performing your analysis. A SWOT analysis should distinguish between where your organization is today, and where it could be in the future.
Next, you will want to determine your company’s profitability drivers. This starts with understanding where you make and lose money. It is easy to equate growing revenues with making money, but unless your operating margin is keeping pace with your revenue growth, you are actually facing a decline in profit.
To understand the profitability picture, you need to analyze the cost structure and contribution margin of each business component separately. A component may be a brand, product, channel or customer.
One common mistake companies make is to allocate a large percentage of their cost structure to “shared costs.” If all costs are not directly attributed to individual components, profitability is likely to be overstated in some areas and understated in others. This could cause a company to make poor business decisions, such as increasing their sales with a high volume customer that is actually far less profitable than is apparent when they should be growing their business with lower volume, higher profit customers.
Consider the following initiatives once you have determined profitability drivers:
1. Re-evaluate all products and services: Consider dropping low volume products or services. Only keep them if their customer reach is strategic in terms of loyalty, satisfaction and relevance. Compare their contribution margin to all other products and services. Evaluate their system wide operational impact on manufacturing and distribution productivity.
2. Realign customers: Renegotiate pricing or completely eliminate unprofitable customers to improve the low-cost and high-cost mix. This may allow for consolidation of facilities, reduction of manufacturing lines and more efficient distribution. Focus resources on profitable accounts with high growth potential.
3. Set long-term strategy: Share your findings with your leadership team so that all future decisions will be based on true costs, system wide impact, and the most favorable profitability strategies.