What drives the value of a business?

Increasing the value of a business may seem like an intimidating process. It could take many years to accomplish but knowing what drives this value is essential to having an impact. Determining ways to grow, reduce risk, and maximize a return on investment are at the core of these drivers.

Most business owners want to know what drives their value for exit planning and strategic planning reasons. When selling a business, the business owner wants to know how to maximize their sales price. This does not happen overnight and takes many years of planning for that exit. Value drivers can also be used in strategic planning to help achieve and measure project goals from year to year. Some top value drivers include:

• Financial strength: Strong financial performance compared to the company's industry impacts value. For instance, monitoring the accounts receivable turnover ratio can give an indication of how quickly sales are converting into cash. A ratio low ratio relative to the industry may indicate the collections process should improve, which would improve future cash flows and enhance the value. Accurate and complete financial statements are critical to measuring performance. Incomplete or incorrect statements provide false information and lack of credibility.

• Financial foresight: Since value is driven by future performance having a long term plan is critical. A documented growth plan shows thoughtful vision about the company. It may lead to new ideas for growth that were not thought of before. Examples could include other markets to pursue, new ways to improve profitability, additional product or service deliverables, and new technology needed.

• Depth of management and sales team: Can the company continue to operate without the owner? Many small businesses depend so much on an owner that no other management and sales team is in place. Having a management and sales team outside of just the owner reduces risk by spreading around responsibilities and customer relationships. It also keeps value in the business if the owner decides to sell and exit.

• Customer concentration: Customer sales are at the heart of value drivers. A common rule of thumb is if a customer or group of customers is over 8 percent of total sales then there may be some customer concentration risk. If one of those customers leaves the company might not be able to survive. Increasing and diversifying the customer base would reduce risk and add value.

• Customer loyalty: Stable cash flows reduce the risk of a future downturn. Recurring customer contracts is an example of offsetting this risk. Returning customers because of quality of service or product adds more value than returning customers because of price. Customer attraction due to lower prices is also not necessarily going to add much value due to uncertainties of the market and industry.

• Product diversification and strength of competition: Diversifying products or services from competition or carving out a niche is critical to growth, profitability, and in turn, value. It also reduces the risk of being too reliant on one product or service.

• Employee loyalty: A company with low employee turnover indicates the staff will more likely remain in place upon a transition. It also indicates that less training costs would be needed for the company thus adding to the future earnings. Implementing incentive compensation plans where employees are rewarded for high performance would be a way to increase value in this area.

• Proprietary content: If a company has created their own technology or process that is in place, value can be significantly enhanced. Unique proprietary content can give the company a leg up on the competition.

It can also give them more control over the resources needed to run the business. Examples would be developing software or having cutting edge processes that improve efficiency. Even having established manual procedures for inventory, fixed assets, employees, and other processes can add value.

• Quality of equipment and facilities: A potential buyer will pay a premium most likely for a well-organized office or warehouse. This increases the value whether selling or trying to improve efficiencies in processes to meet strategic goals.

While there are many areas that drive value, the next step would be to implement a plan to achieve value driving goals.

The business must prioritize the value drivers that are most important, establish goals the business wants to achieve, assign roles to the appropriate personnel, create a monitoring system to track progress, and measure the value created. Once these are established the business is their way to maximizing the value of years of hard work.

• Dan Karnatz is supervisor in Porte Brown's accounting services team, specializing in business valuations and transition/succession planning.