Before your clients list their house on the market they generally go through it room by room and fix it up. They may paint, replace a stained carpet, clean up the garden etc. They make their house look loved and cared for and ensure that it is at its best when prospective buyers walk through at the open for inspection.

Business Value Indications – A Key Advisory Opportunity

With a business it is not that simple, to fix a business up for sale is not a 2-week job. Its not just about replacing a light fitting or removing weeds in the garden. By the time you work out that your business is worth less than you hoped or expected it is too late.

We are entering an interesting time. Baby Boomers born between 1946 and 1964 are aged currently between 51 and 69 years old. The number of businesses on the market over the next few years will sky rocket as the Baby Boomers look to sell and retire. There will not be enough buyers for these businesses. Over supply means a lowering of prices. People who have been relying on the proceeds from the sale of their businesses for retirement, will need to ensure that they can maximise the value of their business in order to get the best possible price.

The question is if I am a business owner, when should I start worrying about the value of my business? The answer is always! A good business is continually striving to improve its profit, cash flow and valuation. 

How does one do that when the process to value a business is so complex? Depending what valuation methodology one wants to use to value a business for a sale or purchase, one has to determine the profit multiple, work out the true valuation of assets, adjust the profit to a sustainable real profit etc. The profit multiple to use is a complex exercise in itself as so many factors need to be considered, such as the industry, the economic conditions and the market.

The good news is that a simple Business Value Indicator can be used to determine a reasonably reliable indicative valuation. So how do you do it? The key is to not get bogged down with complicated valuation concepts and use a simple 5-step approach:

1. Work out the EBITDA for last year
2. Adjust it for significant distortions such as owner not drawing a salary
3. Select a profit multiple that the business should sell for i.e. a good one
4. Work out the indicative value of the business by multiplying the EBITDA by the multiple
5. Subtract any external debt

The result will be the indicative value of the equity of the business and a strong indication of what the shareholders are likely to get if they sold and settled any debt. The indicative value of the equity should be compared to the book value of the equity in the business. If the indicative value is less than book value, then the business is destroying value. In simple terms the business is not generating sufficient profit for the level of debt it is carrying. 

Clients love to talk about the value of their businesses. Anyone over the age of 45 has probably already started thinking about succession planning, and if they are 55 plus then selling their business ‘one day soon’ is probably on the agenda. I recommend Cash Flow Story (www.cashflowstory.com) to show clients the simple valuation indicator as described above. In almost every case client’s value their businesses far higher than the indicative value that is calculated. This creates the disturbance and allows you to show the client how to fix the problem.

Cash Flow Story’s Power of One feature shows the improvement to Profit, Cash Flow and Indicative Business Value that can be achieved by improving the 7 drivers of a business:

1. Price
2. Volume
3. Direct Costs/Cost of Sales
4. Overheads
5. Debtors
6. Stock/WIP
7. Creditors    
 
Having agreed the Power of One changes to improve the businesses Profit, Cash Flow and Value you cannot sell your clients a quarterly Board of Advice monitoring session where you monitor progression and set the goals for the next quarter. 

See how to develop and promote your advisory services at the Smithink Business Advisory Conference on February 4 and 5, 2016 at Hamilton Island. For further information and to register click here.

Do you receive our monthly newsletter? If not, enter your name here and be the first to receive our monthly updates on the accounting industry.

Mark Holton Smithink