We often get asked "what is the best business or industry to invest in?", when the more useful question should be "what features make a business more profitable and valuable?". A business with high than average profit margins and strong cash flow will attract a high business valuation.
Based on feedback from clients and prospects we talk to, we find the two key improvements that most business owners want is:
More cash in the bank.
Higher profits.
So we often talk about the key features that make a business more valuable and what you can do to achieve this. Ironically higher business valuations come from higher profits and increased cash flow.
So we got very excited when we saw two recent blog posts by the virtual CFO business CFO On Call that gave some very good explanations of the things we often see lacking when we do our business valuations:
These posts give some very clear and plain English ideas on the strategies that must be implemented to increase profits and cash flow, and we wholeheartedly endorse every one of them.
However we also want to emphasise how these ideas link together and how they impact a business valuation:
Promoting profitable (and eliminating unprofitable) product/service groups or items
Many businesses have "legacy" products or services - things they continue to offer because of history or a particular market segment that may be important to the business. It is the old 80:20 rule - 80% of revenue (and often profits) come from 20% of the products and services.
However often the business owner does not have sufficient reporting in place to identify the issues. This is a key red flag in any business valuation and we often "mark" a business down because of a lack of sufficient reporting.
And we also find that the businesses that have regular reporting in place that can pinpoint these issues are also the ones that have a higher EBITDA margin (and therefore a higher EBITDA multiple).
Helping with effective staff performance
One of the main business valuation drivers is staff costs - and the major driver of this that the business owner can control is staff productivity.
I was reminded of this in recent business valuations of two IT companies assessing a merger opportunity. One of the major decision factors was whether staff costs would increase per dollar of revenue post merger. Both company leaders had similar approaches to staff performance and business culture and ensured the best features of each business was to be maintained in the new merged business.
Get the culture and staff performance right and staff costs do not depress business valuations and most businesses find they can increase profits as a result.
Ensuring critical customers are effectively serviced and maintained
When doing a business valuation it is easy to see the businesses that have customer service issues - they lack good customer service processes, often have declining (or stagnant) revenue trends and typically blame the results on their customers rather than their actions.
Again in business valuation assessment we go looking for systems on how they handle customer issues and service, what training is in place, how complaints are assessed and monitored and what are the strategic responses to customer issues. We typically find that where the systems are not formal and documented, revenue is rarely on the increase.
Establishing meaningful and effective KPIs to measure results regularly
This is our pet peeve - a lack of regular, transparent and actionable KPIs that help guide the right focus into the right areas. Even businesses in the creative industries space need some reliable KPI's to keep them on track.
Almost without fail, if a business lacks regular KPI's that people act upon, then the business is a lower value than otherwise would be the case. I have seen very simple home-based businesses perform like an industry leader because they reported on a couple of key metrics that told them when the "collective things they do" are not meshing together.
And the list that CFO On Call have provided in Tip 7 in their blog post (7 Tips For Boosting Your Profit by 50%) are an excellent place to start.
It is no accident that most insolvency and restructuring advisers go looking for the absence or presence of these features, because it often leads to the key reasons why a business is under financial distress.
It is worth noting that a good CFO (virtual or otherwise) or accountant will be able to resolve all of these issues and allow you to manage and lead the business.
If you want to read more about what makes a business highly valuable then subscribe to our checklists and feel free to contact us (or CFO On Call) to discuss any questions.
If you want to learn more about the valuation of your business then contact us for an obligation free discussion.
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