Understanding the Value of your Business.
(Back
to Research & News)
Many small and medium-sized business owners are often
preoccupied with day-to-day operations and neglect to
focus on maximizing long-term value. Owners should pay
attention to key long-term value drivers, not only to
ensure future success, but also to prepare the company
for future exit strategies such as additional investments
or sale.
Companies in many industries are often valued based
on a multiple of EBITDA (Earnings Before Interest, Tax,
Depreciation and Amortization). As a result, any plan
to improve future value should focus on increasing the
company’s EBITDA, both in raw dollar value, and
in relation to sales. While each industry is different,
there are many universal key value drivers that can
impact the bottom line, and thus attract interested
buyers. These value drivers include improving operating
margins, consistently growing sales volume, building
attractive customer lists, developing proprietary products
or services, attracting and retaining a strong management
team, and sustaining a competitive advantage.
Preparing and maintaining a detailed business plan is
a good way to keep the company and management focused
on these long-term value drivers. While the plan need
not detail every action that is to be taken over the
next ten years, it should give a broad view of the company’s
overall goal and direction.
A key component of this business plan is a realistic
understanding of the current status and value of your
business. A study of your industry peers will highlight
all aspects of your current performance and help you
plan for future growth by showing how your business
compares to its competitors. For example, do you know
what the operating margins are of your competitors?
Are your margins greater or less than your competitors,
and why? All of this benchmarking information can help
you to focus on improving specific areas within your
company.
If the data on your peers is limited, you can find a
wealth of information by looking at public company financials.
Please note, that the trading multiple (price to earnings,
P/E or Enterprise value/EBITDA) is less relevant to
your company as a valuation basis due to the typical
size and scale of a large public company. The useful
data lies in the ratios that can be easily calculated.
First determine which public companies are most like
your own. Then analyze which companies are the best
performers in the group and do some calculations.
The first data point to look at is profit margin which
includes gross profit, operating profit and net profit.
The better performing companies should have a higher
margin in each category. The valuable information is
what lies within the data, which is why the top performers
have better margins. Look at specific line items and
compare them to your company. Examine specific costs
as a relationship to total sales and determine if these
ratios are in-line with your company. It is not an exact
science, but it will act as a bench mark for goal setting.
While most owners would never enter into product or
service contract negotiations without being fully prepared,
many often enter into the growth phase of their company’s
life cycle short-handed. Setting long-term objectives
and goals is very different from running it on a day-to-day
basis. Every business is different, and needs to be
looked at in relation to its competitors, its industry,
and the economy as a whole.
