Posts tagged with: asset
You already know that your company’s revenue and profits play a big role in how much your business is worth. Did you also know the role that cash flow plays in your valuation and therefore the size of the check you can receive at closing?
Cash vs. Profits
Cash flow is different from profits in that it measures the cash coming in and out of your business rather than an accounting interpretation of your profit and loss. For example, if you charge $10,000 upfront for a service that takes you three months to deliver, you recognize $3,333 of revenue per month on your profit and loss statement for each of the three months it takes you to deliver the work.
But since you charged upfront, you get all $10,000 of cash on the day your customer decided to buy. This positive cash flow cycle improves your company’s valuation because when it comes time to sell your business, the buyer will have to write two checks: one to you, the owner, and a second to your company to fund its working capital – the cash your company needs to fund all immediate obligations like payroll, rent, etc.
The trick is that both checks are drawn from the buyer’s same bank account. Therefore, the less cash the acquirer has to inject into your business to fund its working capital, the more money it has to pay you for your company.
However, the inverse is also true.
If your company spends all its cash as it comes in (like living paycheck to paycheck), an acquirer will calculate that she needs to inject a lot of working capital into your business on closing day, which will deplete her resources and reduce the check she can write to you. Everything she has to put into working capital to continue the business, reduces the available cash that she could pay you and reduces your leverage to command a higher selling price.
How To Improve Your Cash Flow
There are many ways to improve your cash flow – and therefore, the value of your business. Here are just three simple ways you can try now.
- Find a way to reduce the cash you spend on equipment, however you can every time. Can you buy used gear on sites like eBay? Can you share a very expensive piece of machinery with another non-competitive business? Can you rent it instead of buying?
- Reassess your pricing. If you can’t accumulate cash reserves, check to see if you are underpricing your services or if your cost to price equation needs to be reviewed.
- Streamline processes and productivity to keep payroll and services within budget allocations.
Profits are an important factor in your company’s value but so too is the cash your company generates. We call this phenomenon The Valuation Teeter Totter and it is one of the key drivers of the value of your company. Curious to see how you’re performing on a whole set of value drivers? Get your private Sellability Score here.
Lisa Magloff’s article in Small Business Chron, How do I Create Business Value? is a good introduction to the concept of what constitutes value in your business. As she says, ‘It’s more than simply economic value.’ Business value comes from both tangible and intangible assets. To add business value, Magloff outlines five steps. Here are her five steps and my comments.
- Make and keep realistic promises on service, quality and delivery.
This is a great example of intangible business value. Do it well and it will measurably add value to your business. In addition it will result in higher standards of performance and productivity which will produce higher profits. But if you don’t keep these promises to employees, vendors or customers, that intangible value can slide quickly.
- Use information technology to create business value.
Business owners who grew up with technology see how obvious this is. Owners in fields where technology was not available when they built their business can’t see the value yet, because they still need to invest in the technology to make their business viable for the next generation. Technology adds both tangible and intangible value to the business. It can speed up and simplify transactions, and help the business improve overall results.
- Develop and encourage effective decision making practices by employees
Training and support to allow employees to take control of day-to-day decisions on their projects, helps retain them, increases their value to the business, strengthens the depth of management, and distributes responsibility throughout the organization. It prepares employees for advancement and even succession. It also frees up the owner/entrepreneur for more strategic challenges and opportunities while demonstrating that the value of the business is in the business, not in the owner.
- Strengthen your core competencies by investing in development and spending more time and money on those areas that are most important to your long-term success and growth.
To leverage the full value of your business for an acquisition or sale opportunity, it is essential to be aware of your unique strengths to position every asset you have for optimum value. If your biggest asset is your team, invest in them so they committed to stay. If your biggest asset is the process to develop and launch new products ahead of the competition, invest in that, protect it and highlight the value you can monetize just from that.
- Increase your business value by building capability within your business
Capacity building can be achieved in many ways. It depends on your objective and long term goals. Adding employees is one way, but that’s not just about hiring. Once you add employees, you need to nurture them with training and knowledge to cultivate innovation to continually add value to the business. Capacity building can be about your brand and market perception of your value. It can also be about the right technology or adding technology to support increased capacity to serve the market. Every one of these approaches to build capacity sets up your business to grow, increase revenue, and add value to the bottom-line.
Creating business value is a process. Systematically building both tangible and intangible value will position you better for a sale or acquisition on your terms, on your timeline.