I own a system integration business that specializes in the food service industry. I enjoyed the blog you wrote about 8 Ways To Drive Value In Your Business. It got me thinking about my business, but I could use help thinking through specific ways I could use these concepts, especially those related to improving my financial acumen to drive value in my business.
Thank you for your question, I’m so glad to hear you enjoyed the blog!
I’ve often said that you would not let your 401(k) sit for years without checking the performance and balance, so why would you not want to know the value of your business, especially since it is likely your most valuable asset?
You’re smart to be thinking about how you can better understand and increase value in your business much like you, or your financial advisor, work to rebalance and increase value in your 401(k) from time to time. Understanding the drivers of value in your business allows you to make smart decisions that enable you to increase value over time.
As noted in my earlier blog, there are eight key indicators of value we use as a framework for driving value in a business. Here is a link to my original post with the list of all 8 Key Drivers of Value, but because you’re most interested in understanding the financial drivers first, I’ll start there.
Understanding Financial Performance to Drive Value
Business owners are accustomed to watching revenues, but that’s only one piece of financial performance and frankly, not the most important. Understanding the power of increasing your margins and profits will provide a much larger payback.
You can use the following questions as a guide to review your company’s financial performance and improve your understanding of some of the most critical levers to drive value.
First, lay your company’s last five year-end income statements side by side. If you can do this in an Excel spreadsheet it will make it easier to compare and understand the historical trends in your revenues and expenses. We’re going to be looking at historical trends related to Revenues, Gross Profits and Operating Expenses, since trends are a strong indication of future performance. Here are some questions for you to consider:
- Are revenues decreasing, holding steady or increasing? Buyers like to see steady, gradual growth, not a lot of peaks and valleys.
- What percentage of your revenues are repeating, or recurring, from year to year? Recurring revenues can benefit your business now, as well as increase the attractiveness of your business to a potential buyer.
- Do you have contracts with any of your customers that define the length and terms of your relationship? Buyers like contracts, if they are assignable, because contracts can help them transition and retain clients.
- Are your company’s gross profits (revenues less cost of goods sold) increasing as a percentage of sales? Even a 1% improvement in gross profit can have a significant impact on value.
- Here are just a few ways to increase your gross profit margin:
- Can you negotiate a lower cost of services or products delivered?
- Can you negotiate with your customers to share in the cost of freight in or out, or travel expenses if you are a service provider?
- Can you improve your inventory turns?
- Compare the past five years of Operating Expenses to identify any trends that do not seem reasonable. Take the time to dig in (possibly with your accountant) to understand what is included in the expense categories. If there is an anomaly, the expenses may not be categorized consistently. Or, it could be a non-recurring, one-time expense. It could also be time to speak to a vendor about renegotiating prices, as costs have a way of creeping up year over year.
- Document any one-time, non-recurring events so down the road you can explain any inconsistencies to a potential buyer. Even if you do not plan to sell soon, this can help you feel confident that your expenses are being categorized properly.
- Here are some questions you can ask yourself related to your Operating Expenses.
- Labor – what are the current market trends? Are you at, or close to, market levels in terms of your team’s size and compensation levels?
- Insurance – how do your premiums look compared to the benefits of your plan? Shopping for insurance is not something most business owners like to do, but is it time to get competitive estimates again?
- Are there expenses you can outsource and save money at the same time? Payroll processing is one example.
After you’ve analyzed the above data, there are other helpful tools for understanding your company’s financial performance.
- Do you have access to industry data to benchmark your company’s performance against others? This can be a meaningful way to identify where your expenses may be out of sync, relative to your revenues.
- Are there certain products or services your company provides that have a very low profit (and not high volume)? Is it time to say goodbye to some product(s) or customer(s)?
- What is the quality of your company’s financial statements? Keep a consistent chart of accounts so year-to-year comparisons make sense.
- Are your financial statements compiled, reviewed or audited by an outside accounting firm? While reviewed and audited statements can be expensive, investing in them 2-3 years before selling can lend credibility to your financial accounting.
When you have completed the above analysis, either on your own or with your accountant, you should have a better idea of what a buyer would be interested in.
The next blog post will address the rest of your question and focus on the remaining value drivers. If you or someone on your team would like to discuss any of these concepts with me please email me at firstname.lastname@example.org.
Cathy J. Durham is the president of Capital Valuation Group, Inc., headquartered in Madison, WI. Capital Valuation Group has specialized in business valuation since 1974 and is committed to delivering meaningful valuation conclusions in a way that helps business owners understand and maximize the value of their businesses. Cathy is an Accredited Senior Appraiser through the American Society of Appraisers and a trusted expert witness.