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How Can You Increase the Value of Your Business?  Our Value Enhancement Plan

This question is of interest to virtually every business owner. However, before we can outline how an owner can increase the value of a business, we need to clarify just what determines the value of a business. The value of a business is measured by determining two factors:

· The amount of cash it is expected to generate for the owners in the future
· The probability that the business will in fact generate the expected cash

Unfortunately, both of these items are not easy to identify. A business’s value is based on its future cash generating ability; not what it has made in the past. Often historical results are a good clue as to what can be expected in the future, but many things can impact the future either negatively or positively. The probability that the business will in fact generate the expected cash is defined as the risk associated with the business. Each investment has its own specific degree of uncertainty whether or not the forecasted (expected) net cash flow will actually be realized. This degree of uncertainty is called the required rate of return or the weighted average cost of capital (WACC).

Now in order to create value, all you have to do is pursue strategies that increase the net cash flow, reduce the risk, or a combination of both of these factors. However, applying these concepts is more difficult than identifying them theoretically.

Most business owners can see the direct relationship between increasing sales or decreasing expenses and increased profitability. However, many fail to see that sometimes increasing sales can decrease profitability or reduce value. For example, cutting prices generally results in increased sales. However, it is possible to reduce margins to the point where the business, after increased operating expenses associated with the increased sales, loses money on the increased sales. Not a good idea!

Another way to increase sales is to relax accounts receivable terms and credit policies. If a company sells to anyone who is willing to buy on account, the collection period for accounts receivable is going to increase thereby reducing the company’s cash flow and bad debts resulting from non-collectable accounts will likely increase. The cost of these increased sales can be enormous.

There are many factors that drive value in a company. Value drivers are typically divided into three groups:

· Profitability Value Drivers -- such things as targeting specific customers, advertising and marketing policy, pricing policies and inventory choices and costs.
· Asset Turnover Value Drivers -- such things as credit policy and collection procedures, discounts and allowances, supplier capabilities and agreements, and capital expenditure needs and procedures.
· Risk Value Drivers – these are based on the strengths and weaknesses of the business compared to others in the industry.

A business owner must be careful that the strategies adopted designed to increase cash flow do not lead them away from their core business into new, unproven areas as this type of action will increase the business’s risk. Each strategy that is adopted must be reviewed for its likely impact on both the business’s net cash flow and risk profile. The key is to pursue strategies that create net cash flow and have the highest likelihood of success or strategies that result in reducing the company’s risk.

The process of identifying strengths and weaknesses goes beyond a review of the historical financial statements of your business. Financial statements show the result of what happened, but, they do not reveal the causes.

A comparison of a company to the industry is the place where this process begins. The idea is to determine how risky a business is when compared to others in the industry; its competitors. The key is to look to the future—to anticipate how a business’s strengths can be maximized and how its weaknesses can be minimized. During the process of determining the estimated current value of a business, a business’s strengths and weaknesses are identified and the level of risk associated with a business is determined.

One of the services we provide clients is called a Value Enhancement Plan. In this plan, we analyze a business, determine its value and risk drivers and make specific recommendations that a business can implement to maximize profitability and value.

Call us for more information or for a quote.