When someone buys public company stock or shares in a mutual fund, there is an inherent expectation that the asset will increase in value. For many business owners, their ownership stake in their company is their greatest financial asset. Yet, too many owners don’t treat their business like an investment. There is usually very little that an average investor can do to affect the earnings of a publicly-traded company or a managed mutual fund. However, as the owner of a business, there are many ways in which you can directly influence the value of your business.
In basic valuation theory, a company’s value is most often driven by the cash flows it is able to generate and by the risks related to generating those cash flows. This is why a standard metric for valuing businesses is based upon applying a multiple to a company’s EBITDA (earnings before interest, taxes, depreciation, and amortization). EBITDA is a common proxy for measuring a business’s cash flows, and the multiple is a measure of the risks related to those cash flows. Knowing this basic formula gives business owners two major levers they can pull to affect the overall value of their company.
Lever 1: Cash Flows
There are a variety of ways to influence a company’s cash flows but, in basic terms, they all involve either increasing revenues or cutting costs and improving efficiencies.
To increase revenues, a business can 1) sell its existing product and/or service offerings to new or existing customers, or 2) expand its products or services into new geographic markets. These expansions will often require making investments back into the business by hiring people, purchasing new equipment, acquiring new technology, or buying an existing business that already possesses these attributes.
One way to identify cost reductions and improve efficiencies is to complete a waste reduction project. The process will help you take a fresh look at your existing processes, which can be an effective and eye-opening way to identify areas for improvement.
Lever 2: Risk Management
There are myriad risks when running a business. There are external factors such as rapid changes in technology, changes to the competitive landscape, regulatory compliance, and cyber security concerns, among many others. Businesses also face many internal factors, such as management depth and ability, customer concentrations and makeup, over-dependency on the owners, and the lack of contingency or succession plans, just to name a few.
A company that has fewer risk factors is going to be worth more, since an outsider will view it as a “safer” and more reliable investment. Companies that make concerted efforts to reinvest back into their company by developing their management team, putting together an outside board of advisors, and documenting contingency plans will see a payoff in the form of a greater business value.
Attempting to tackle too many of these issues at once can be overwhelming. But, focusing on one or two items a year over a sustained period of time can result in dramatic improvements to the value of your business.
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