An abundance of valuable elements gives businesses strength, endurance, long-term profitability, and increased cash flow. Whether you are exit planning, estate planning, preparing a buy or sell agreement, or simply desiring to make your businesses more pleasant and profitable, it is important to pursue the most valuable characteristics.
Below, we explore the top five tips to increase business value.
Diversification
Diversification is an essential component to long-term business growth and risk mitigation. Although client diversification is one of the most common areas suitable for emphasis, products and suppliers should also be considered. Unfavorable external circumstances can occur unexpectedly. However, businesses with diversified prospects are often more apt to respond well.
Potential buyers often see diversification as risk prevention, a valuable business characteristic.
Diversified Customer Base
Generally, no single customer should account for over 8-10% of total sales. When a business possesses a concentrated customer base, dropping one major client could result in devastating losses.
Additionally, customer concentration is often a red flag to buyers for multiple reasons. For one, if a single client, perhaps generating 40% of sales, leaves upon sale of the company, the buyer is left in severe economic conditions. Furthermore, if one or more significant customers are loyal to you or a select team within your business, an inside buyer may see a cause for concern.
Diversification is among the most important tips to increase business value. Even if multiple business value factors are in place, such as cash flow or proven scalability, a lack of diversification is a red flag. As a rule of thumb, evaluate your company as a buyer would. Would you honestly accept the risk of purchasing the company after considering the customer base?
Business Scalability
A scalable business is demonstrated by simultaneously increased profit margins and revenue. Therefore, profit margins should increase when revenue increases, and vice versa.
How does this occur? If revenue increases and costs remain relatively stable – rising slightly, but at different rates – profit margins will also increase.
For example, a software company with the ability to build a program for resale is extremely scalable. As the software is purchased, the cost to produce it remains comparatively stable while revenue increases.
At times, increased revenue is almost invariably tied with increased cost. However, scalability is still possible if you own a business with less repeatable infrastructure. Other elements impact increased profit margin, such as an efficient business model. While owning a brick-and-mortar home goods shop might be more challenging to scale, maintaining a valuable business model while multiplying locations will ultimately impact profit margin – even without significantly decreased costs.
Predictable Cash Flow
In many circumstances, predictable cash flows show enormous value. Volatile cash flow streams may appear risky to potential buyers. However, this is not an ultimatum.
For example, a snow plowing company will likely see good cash flow in mild winters, excellent cash flow in harsh winters, and nonexistent cash flow in the summer. A diversified company that also does landscaping may see consistent cash flow year-round.
Looking at the companies in the above paragraph, while one company demonstrates volatile cash flow patterns, both could demonstrate the same amount of value to a potential buyer. Generally, however, exhibiting a history of stable cash flows shows reliability in the business.
Improved Margins & Commoditization Opposition
Business margins and commoditization often work together. Commoditization is often defined as the process by which unique, distinguishable, and valuable goods become single commodities in the eyes of consumers or clients.
When commoditization occurs, operating margins tend to decrease, even if revenue increases. Business owners can battle commoditization in a few fundamental ways:
- Innovation can be demonstrated in new products, better designed to meet needs, or existing product upgrades. Providing additional value unique to your business can give you a competitive edge over your competitors.
- Segmentation is possible in mature markets. Large target markets can often be divided into customer segments, groups that can then be strategically targeted for different products or services.
- Bundling a product – especially a commoditized item – with additional services or ancillary add-ons can heighten buyer appeal, making the product appear unique and convenient.
Harvard Business Review writes:
The truth is, even when a raw material has no value added and quality standards are set by law or the industry, there is still plenty of opportunity for differentiation around availability, delivery, shipment quantities, payment terms and all the other services that accompany the core product. Marketers must use their imagination. As the saying goes: ‘There are no mature products, only mature managers.’
As a business owner, strategizing to prevent commoditization in advance can increase business value.
Financial Forethought & Controls
Financial forethought involves comprehensive financial controls. Without the ability to properly report and evaluate revenue and cash flow, buyers are often unable to accurately understand past growth or predict future profitability. Additionally, unclear financial reporting can point to potential problems.
As a business owner, you should have a clear understanding of the financial condition of your company at any given time. With the help of a trusted CPA, forecast upcoming financial demands based on your growth plan goals.
DHJJ: Business Valuation Services
At DHJJ, our advisors understand the importance of knowing the true value of your business in a multitude of situations – from estate planning and exit planning to buying/selling agreements.
Regardless of the circumstance, business owners need a realistic understanding of company value in order to develop value drivers. At DHJJ, our business valuation services provide organizations with a clear picture of company value, beginning with a SWOT analysis.
To get in touch with our team, feel free to call one of our locations (Naperville: 630.420.1360, St. Charles: 630.377.1106) or complete our online contact form. A member of our staff will reach out shortly!
