RECOGNIZING THE IMPORTANCE OF YOUR
BUSINESS VALUATION
If you don’t understand the valuation and numbers of your business…you are simply killing yourself.
In 1977, a guy walks into a lingerie shop to buy his wife some lingerie. Feeling uncomfortable and like a pervert, he walks out frustrated. Thinking the way so many other men may have felt, he came up with the idea to open a convenient and affordable store for both men and women to feel comfortable buying women’s lingerie. So, he gets a $40,000 bank loan and borrows another $40,000 from his in-laws. In the 1st year, he makes $500,000. He then creates a catalog and opens 3 more stores. 5 years later this, guy, Roy Raymond, sells the company to Leslie Wexler, owner of the Limited brand for $1 million and a position as president for 1 year. Two years later Leslie Wexler sold that company for $500 million. After finding that out Roy Raymond jumps off the Golden Gate Bridge killing himself and the store is Victoria’s Secret.
I bring up this choice story as a business parable. If you don’t understand the valuation and numbers of your business, you are simply killing yourself.
When evaluating a business, people expect that their investment will grow by a certain amount above the cost of that investment. That certain amount of growth gives standing to that level of risk. When you attempt to focus on the quarterly earnings outlook and short-term gains, you slowly erode the wealth-building system in your business. Conversely, the stock market tends to focus on short-term gains to appease institutional investors. Their timeline for returns is normally short-term. In a small business, your goal is to either give value to the business, sell it at some time in the future, or you’re going to grow value until retirement. If this is your focus, it would be counterintuitive to focus on short-term gains, rather than valuation.
A small business is often the biggest asset that an individual owner may have. Whether it’s a sole proprietorship or a partnership, the daily tasks are a very small part of the ownership duties that a small business pays attention to. Analyzing and making strategic decisions to grow your business is vital.
When you approach the time to put up the for-sale sign for your business, having complete documentation of the company’s valuation as well as its growth projections is crucial. Know your numbers!
A Business is not a liquid asset
Being able to find a buyer may prove difficult. But the biggest caveat that you need to watch out for is a buyer who’s seeking a specific return on investment. Just as real estate investors may look for a specific Cap Rate when purchasing a property, investors in small businesses will also be looking for a specific rate of return on their money. If your company has a $2 million valuation and it’s growing at 10% annually but only has a return on investment {ROI} of 8% in a market niche that is getting 15% returns, that $2 million valuation may be expensive in the marketplace. Underperforming in the marketplace will not support this valuation.
The problem for small businesses is that because they are so illiquid, there will be uncertainty about when the next offer will come along. So, it’s important to know your valuations and give buyers confidence that the value of the company is a solid and accurate one. Also building attainable growth levels.
Understanding Your Company’s Valuation
Understanding your company’s valuation brings clarity to many simple objectives in the future. Knowing the growth of your company’s valuation over the years to determine its valuation in the future is vital. Some of the most simplistic reasons would be:
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To sell your business
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To qualify for loans
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To buy another company
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Intellectual Capital
Your business also has more value than what is on the shelves or the building itself. Sales growth is great, but managing the cost of sales is greater. The system to keep most of the sales dollars in your pocket is a distinct characteristic of business management systems.
The intellectual capital of the owners; the use of their primary skills, how those skills make for unique services and products, and the process of measuring value, is the focus on return on investment. This is accomplished by making better operating management decisions. Thus, the true marketable value of intellectual capital is in the development and documentation of systems. Managerial systems and unique processes that bring your services or product to light. A true test to this is if you leave the business for some time would the company work seamlessly, and productively run without you being present? Clear and effective management systems within the workforce, makes for high proficiency, and makes for happy work staff, and happier returns.
Cash Flow
Positive streams of cash flow and predictable streams of cash flow solve most short-term financial issues. Future cash flows are absolute to the value of a company’s bottom line.
This is not to say that growth is bad, but a focus on return on investment is better in many ways. Many small businesses have suffered futility because growth has gotten out of control. Often, too fast of growth can begin to bottleneck your streams of cashflows and force you to come to a complete halt. Issues with getting paid by customers who may have an N90 payment schedule will create short-term cash flow problems when you are trying to meet payroll or pay vendors who require N30 payments.
Knowing your numbers means that you fully understand and are prepared for the numbers that a bank may ask to acquire a loan. If you are proactive and prepared for banking requirements for a loan, you will be forward-looking onto the analysis of your business financials to make growing decisions. Knowing your financials will allow you to acquire competition. You will find yourself measuring your competitor’s number versus yours, and you will be able to assess their valuation quickly, and because they may not know their numbers you can acquire them cheaply.
Let us help you find your business valuation with many Key Performance Indicators.