We get up every day and work at our businesses. We give the business our labor and our souls. We get some income from it and intend to continue doing it for the foreseeable future. Why worry about the value of it now?
Then your competitor suddenly has a heart attack and dies. His grieving widow comes to you asking if you would like to buy the business at a bargain price so she can move away and live with her children and grandchildren.
His business includes the real estate, in a better location, and would more than double your market share. The combined enterprise would be large enough to hire a manager so you could actually take a day off from time to time and see your own family.
Now you need to borrow some money to make it happen and the bankers are inspecting the value of your business.
The key: Value is based on performance over the history of the business. Value is not based on a single year.
It is essential to continuously build the value of your business so you can seize opportunities when they come along, and pivot when life throws you the curve ball.
Value is based on only 2 things: Cash flow and Risk!
Cash Flow is the normal cash from operations. That is, the amount of cash that is left after paying all the necessary expenses, at market rates, to generate the stated Revenue.
Risk is an assessment of how risky your business is compared with other similar businesses and other investment options. If for example, you think your business is worth a million dollars, consider what else an investor with a million dollars could invest in, and what return he could get from it at different levels of risk.
Risk is the basis for estimating the rate of return an investor would require to invest in your business.
There are many factors that affect the risk of private enterprises. The economy, (national, state/provincial, and local), has a tremendous influence on businesses pushing the expectations of success up or down beyond the control of the owner.
The competitive environment is critical. Consider the Marina that has the only permitted lease on a major tourist lake, compared with an independent coffee shop on a street where Starbucks is likely to build a new location across the street. The Marina is much less risky than the coffee shop.
An Owner has control over many risk factors inside his business. A Dealership with long term skilled staff in all the key roles is much less risky than a dealership that has high turnover and inexperienced staff in management roles.
A business that is meeting or exceeding industry financial benchmarks is less risky than one that is not.
And a business that presents smooth consistent upwardly trending Revenue and Cash Flow is less risky than one that experiences significant ups and downs. Everyone wants consistent cash flow!
Intuitively, we all realize, the lower the risk the higher the value, and the more cash flow generated the more valuable the investment.
Keep these factors in mind as life in your business unfolds. Always work to maximize cash flow and minimize the risk of your business so you have the value necessary to take advantages of opportunities and avoid the curve balls that will inevitably come along.
By Carrie Stacey, CPA, CVA, CPA(Cdn)