How Do I Increase The Value of My Business? - Part Two
Welcome to the second part of our series of articles about how to enhance the value of your business. You may remember from last time that we were talking about the following:
Our life in business is full of actions, some of those actions create value, some reduce value and some are value neutral. Obviously the key is to concentrate on those actions that enhance value, minimize or eliminate those that have a negative impact and at least understand that other actions may make sense but have no discernable impact on value.
In other words, you should review your action plans to ensure that you concentrate your efforts on enhancing value.
First of all we need to remember that for an action to affect the value of the business (either positively or negatively), it has to do one of the following:
- Affect current cash flows (or)
- Affect future growth (or)
- Affect the length of the high growth period (or)
- Affect the discount rate (cost of capital)
Increase Cash Flows from Assets Already in Place
The assets already in place for a business reflect historical investments made by the business. If these investments in assets were not optimally made and/or poorly managed, it is possible that value can be increased by increasing the after-tax cash flows generated by these assets.
It would follow that a business that can increase its current cash flows, without significantly impacting future growth or risk, will increase its value. In other words, if all else remains constant a business that generates more cash flow will improve its value.
Ways of Increasing Cash Flows from Assets Already in Place
Poor Investments - Maybe you should divest?
Most businesses have at least a few investments that are earning less than the cost of capital or even losing money. Initially, it may seem that eliminating or divesting of these investments would increase value. Unfortunately, that isn’t always the case where you are unable to recover your invested capital.
You should consider the options available to you and the values that might be derived. It would follow that you should select whichever option provides the highest after-tax value to the business.
These include:
- Value in continued use = the present value of the expected cash flows from keeping the asset to the end of its’ useful life
- Sale value = The net price that will be paid by the highest bidder for this investment
- Liquidation Value = The net cash flow that the business would receive if it liquidated the asset/investment today
More Efficient Operations
The operating margin for a business is a function of how efficiently it operates to produce the products and services that it sells. If a business can reduce its costs, while generating similar revenues, it will increase its operating income and ultimately its value.
Cost cutting and layoffs are often sited as the first step of value enhancement in many businesses. Since they occur quickly and are tangible, the effect on earnings (and value) is immediate. Of course, they must be sustainable over the long-term in order to truly impact on value.
We know that not all cost cutting is value enhancing. If a business cuts expenditures which are designed to create future growth (research and training expenses, for instance), they might report higher operating income but value might drop since the business’ future prospects have been sacrificed in order to get short term gains.
Increasing margins
A more palatable manner in which to increase value (at least from the perspective that it doesn’t negatively impact on the workforce) is to improve the business’ margin through any number of ways including a price increase, dealing with more profitable customers or eliminating less profitable customers . This has the same effect as a more efficient operation without having to sacrifice long-term growth through reduced expenditures in key areas associated with the business’ development.
Article published with permission from Graham Mathew & Partners LLP and Ran One
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How do I increase the Value of My Business? - Part Two
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