By Edward L. Fixen
As business owners we spend considerable time trying to increase sales and reduce expenses. While these are critical to the profitability and value of any business, they are by no means the only factors that are instrumental to increasing the value of a business. Anything that reduces business or financial risk increases the certainty of future income and materially increases the value of a business. This article highlights ten key factors that every business owner should consider and develop a plan to increase the value of their business.
- Stability of Earnings– This factor takes into consideration the age of a business, how volatile or stable the earnings have been historically and how the profitability of a business compares with industry peers. Developing creative and aggressive sales strategies to maintain stable or growing sales complemented by operational strategies to improve profitability through expense reduction will definitely improve your bottom line and increase value. A strategic and annual planning process that includes development of both a long-term strategic plan and annual operating plan is a great mechanism for not getting stuck in status-quo mode and staying ahead of your competition.
- Business Growth– Business development strategies and capital investments that help your business grow faster than the overall industry growth rate will increase the value of your business. The key here is to find ways to have managed growth exceeding your industry peers. This factor could include both marketing/sales plans to increase growth to existing customers, expand to new geographic or industry markets, capital expenditures to increase capacity or productivity, operational strategies to improve efficiency and organizational strategies to support growth.
- Industry Growth– Providing products or services to customers in high growth industries is an excellent means of increasing the value of your business. Every business owner should explore sales strategies to target high growth industries. For example, a machine shop that serves customers in the medical device or healthcare industry have a stronger growth story than the same company whose customers are all in the aerospace industry.
- Customer Base & Concentration– A key risk consideration that is commonly found in small, private businesses and significantly affects business value is the degree of reliance on a small number of customers for a large percentage of revenue. While taking on a large customer can have strategic value, a disproportionate reliance on one or a few customers is generally viewed as high risk that reduces the value of the business. To the degree practical, it is important to develop a diverse customer base over time and reduce reliance on any one or small number of customers. Ideally, no single customer would account for more than 10% of annual sales.
- Depth of Management– Many businesses are far too reliant on the owner for the specific knowledge and/or relationships that are critical to the success of the business (i.e., “the owner is the business”). In these situations, when the owner leaves or wishes to sell, the necessary knowledge and customer relationships critical to the business leave with the owner. The lack of depth of management adds significant risk to the business and can greatly reduce the business value. The value of a business can be dramatically increased by developing and mentoring key employees. Ask yourself if you could take an extended vacation or sick leave without worrying about business in your absence. When you can say yes to this question, you have truly increased the value of your business.
- Have a Plan– Most businesses don’t have a business plan but would benefit greatly from the exercise of developing an annual operating plan and long-term strategic plan. The planning process usually results in the identification of beneficial changes and improvements that increase the value of your business.
- Long Term Contracts– The development of long term contracts is a very effective means of increasing business value, not to mention peace of mind. Help your customers understand the win-win that results with long term contracts. It is usually possible to offer reduced pricing without compromising profits when you can count on annual sales from a customer and more efficiently plan for the delivery of your products or services. In turn, the value of your business will increase because future income streams become less risky.
- Diversity of Products, Services & Markets– Similar to the benefits of a diverse customer base, revenue that is derived from a diverse base of products, services or geographic markets is also an effective means of reducing business risk and increasing the value of a business.
- Financial Records– The importance of high quality financial records is often overlooked. Increasing the accuracy and transparency of financial records not only helps you better understand opportunities for improvement and increased profitability, it improves the confidence of lenders and investors, both of which increase the value and salability of your business.
- Strong Balance Sheet– A strong balance sheet with good assets, healthy inventory levels (i.e., not too much and not too little), adequate working capital and low debt-to-equity are very important indicators of the strength and management of a business. Owners should strive to achieve balance sheet targets in line with or better than industry averages. An industry benchmarking analysis can easily be performed to see where you stand relative to your competition.
Naturally, there are other factors that affect business value, such as location for a retail or restaurant business, but the factors discussed above are intended to identify the ten key factors that business owners can actively address to increase value.
Author: Mr. Fixen is the President of BusinessQuest, a business valuation and M&A brokerage firm serving small & mid-size, privately-held businesses throughout Southern California. Mr. Fixen is a Certified Business Appraiser (CBA) and Certified Business Broker (CBB). Ed can be reached at firstname.lastname@example.org.