Valuation analysts often work with business owners to determine the value of their business prior to a transaction. When a transaction is nearing, it’s likely too late to make important changes, but for those of you who are at least a few years from selling your business, consider the following.
Most investments, whether a business, a bond, or a stock have one thing in common. They all involve potential future cash flows, meaning earnings, dividends, or interest to be paid to the holder at some future time. If no cash flows are expected, the value is based on a future sale price and assumes the assets used in the operation will change in value over time, and cash may be generated at some point along the way. Using the expected amounts and timing of these cash flows along with the cost of the capital being used to purchase the investment, an analyst can make an educated estimate of the value of the business.
Knowing the focus is on cash flow, the astute business owner should attempt to maximize cash being generated. However, this brings up one of the biggest dilemmas an entrepreneur might ever face. Cutting costs raises cash flow, so doing away with excess capacity in labor, inventory, and fixed assets may look like attractive choices, but if it harms the customer experience, revenue might decline along with it. That said, the entrepreneur should strike a balance between efficiency and brand damage. Products and service should never be sacrificed to improve profitability. However, finding a new source for supplies or inventory without compromising quality while lowering prices is always a great idea. Alternatively, in-sourcing a process when you have traditionally purchased it from an outside source, may just be the needed change for increased profitability.
Also, remember profit is not always the only consideration. Raising profitability is generally a positive, but make sure cash flow is increased in the process. Using return on investment (ROI) can lead you astray while net present value (NPV) of investments is the best comparative measurement of profitability for business decisions.
If you don’t recall the difference, contact the Business Valuation Experts at Henssler Financial: