Profitability’s Impact On Value

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This is the ninth article on “profitability”—a guide to help understand and develop the true significance of its impact on a business: revenue growth, peace of mind and freedom to do about whatever you want to do.

 

Imagine that you are like Joe, who plans to operate his business another five years before he wants to sell his company and retire.  Joe is like most business owners where the majority of his personal net worth is tied up in the business and he needs to sell the business to create the liquidity for retirement.  How should Joe approach profitability these next five years: (1) take most of the profit out and invest it outside the company, (2) invest it in growing revenue (make no profit), (3) operate as usual and hope for the best, or (4) try to maximize and grow profit?  What is the best use of Joe’s time and energy?

The best approach for Joe is to look at it as a potential buyer would.  What are the key factors most business owners are looking for?  They are looking for historic cash flow which is an indication of what the future holds to be able to pay Joe the money he wants for his business.  Joe can also increase the value of his business dramatically buy focusing on improving profit.

Here is an example of valuation.

Assets        $2,000,000
Liabilities,   $ 500,000
Equity         $1,500.000

EBIDTA     $200,000
Business will support a 3.5 multiple of earnings
EBIDTA value $700,000

Business value $2,200,000

But Joe is really focusing on profitability and takes profit from 3.3% of revenue ($6,000,000 in revenue x 3.3%=$200,000) to 5.0% of revenue, or $300,000 a year.

The valuation would look like this:

Assets         $2,000,000
Liabilities,    $ 500,000
Equity          $1,500.000

EBIDTA     $300,000
Business will support a 3.5 multiple of earnings
EBIDTA value $1.050,000

Business value $2,550,000

If Joe was very aggressive and improved productivity, cut out all the waste and took profit to 10% or making $600,000 in profit, the company would be worth $1.8M + $1.5M, or $3.3M.

So by paying attention to profitability, Joe can have a huge impact on the value of his musiness by an extra $1,000,000.  Is that worth the effort?  If you want to dramatically improve profit and don’t know exactly how to go about it, call me and I can give you a few tips that will shorten your learning curve.

Focus on your profit this week, this month and this year.

Dan Lacy

The Business Growth Coach