Indicators of business value

indicatorsSome of the most frequently asked questions by Maxik’s clients – often when they have just started to think they might sell their business at sometime in the future are: “How can I sell my business for more?” “How can I maximise the value of my business before going into sale mode”; or “How do I maximise earnings before sale”. These are simple questions but the answers have many complex dimensions.

My advice is that it’s critical to understand how businesses are acquired and the logic and psychology of the buyers.  Buyers with serious money to spend will engage or have a professional business valuer. If not they will certainly apply valuation techniques in forming a view of your business. And in most cases the methodology used to value a business is based on a Discounted Cash Flow (“DCF”) or Net Present Value (“NPV”) analysis. In simple terms: What is the value, in today’s dollars, of all the future net cash flows, both positive and negative of the business?”.

It is the understanding of the factors used by professional values in setting the discount rate for the analysis that gives a clue as to how one might increase the value of the business. In short, the lower the discount rate the higher the valuation of the business and visa versa.

It is therefore most useful to look at and understand the typical factors considered by professional values in setting discount rates, as they influence not just the discount rate but the underlying value itself from a buyer’s viewpoint. Here is a list of some key factors, as adapted from the Institute of Chartered Accountants in Australia course on Business Valuation.

One of the techniques I use to assist my clients who are in “presales mode” is to take them through each of these factors to see if and how they might improve them. You may find it useful to run this analysis across your business. They key is then to work out how to influence the factors so as to increase earnings and or sales price in the period leading up to sale. This is not a quick fix but may require a period of intense study, planning and implementation over a 12 to 24 month period.

If you need some help in understanding these factors or developing a plan to effect a positive change please contact us, that is our speciality and expertise. We also specialise in focusing these factors through the positioning of your brand.

Impact on Discount Rates

FactorLower = BetterHigher = Worse
Business Growth & Opportunities Above industry norms Expansion from existing services in existing markets Below Industry norms Expansion based on new services or markets
Products & Market Diversification Diverse products and multiple markets Limited product lines and markets
Competition Few competitors / high barriers to entry Highly competitive / unstable market
Revenue Concentration / Seasonality A large number of customers No seasonality or cyclical revenue High customer concentration (few) A few customers are >50% revenue Highly seasonal or cyclical revenue
Forward Orders & Reorder Patterns High future revenue with forward orders Long term relationships with renewals High Customers switching costs / timing Price not a primary purchasing factorFuture revenue not underpinned by forward orders Once off, “lumpy” or regular rebids in a competitive process Customers have low switching costs Customer very price sensitive
Contractual Relationships Long term stable customers Contracted (price and volume) or Cost plus (type) contract Short history and or high churn Uncontracted or Fixed Price Contracts
Nature of Costs High proportion of variable overheads High proportion of fixed overheads
Stability and Skills of Employees Stable well trained & motivated teamHigh turnover and /or unskilled team
Business Systems Business process highly systematised and requires little modification between clientsBusiness process or service is highly customised by client and / or assignment
Management Involvement Limited ongoing management time Significant ongoing management time
Stability of Historical Earnings Stable and above industry norms Marginal, erratic, < 3 yrs good history or below industry norms
Working Capital / Payment Terms Little if any working capital requirement and /or upfront / contract paymentsHigh WC requirement or progress payments not agreed in timing or amount
CAPX CAPEX less than depreciation Significant CAPEX or guarantees

Source: Based on ICAA Valuation Course

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