Business Valuation Trilateral: Risk, Profitability and Growth

by Kelly Deis of SoundPoint Consulting

Most business owners focus on increasing profit margins as the only means of improving the value of their business. Profitability is absolutely important, but it is not the only factor to consider.

In fact, there are three components which can increase – or decrease, the value of a business: risk, profitability and growth.

Take for example a recent client. We determined the valuation of the business to be about $1 million.

We then illustrated that if they were able to incrementally decrease risk, improve profitability and accelerate growth, they would be able to realize as much as $300,000, or 30% of additional value.

  • Decrease risk (discount rate) 2 pts: $80,000
  • Increase profitability 10%: $100,000
  • Increase annual growth 2 pts per year: $120,000

Now, will this client be able to realize the full $300,000 in incremental value? It really depends on the timeframe and level of effort that they want to put into improvements. It is a good idea to identify the range of opportunities and then prioritize activities.

Generally speaking, decreasing risk is easier than increasing profitability. And for mature businesses, increasing profitability is easier than achieving high growth rates. Here are some things to think about when assessing your opportunities:

Risk:

  • Do your top five customers comprise more than 15% of sales?
  • Are you dependent upon just a few suppliers? Are they in good financial health?
  • Could your business successfully operate without you or other key employee(s)?
  • How loyal are your customers?

Profitability:

  • Are your gross margins and expenses in-line with the industry?
  • Are you operating as efficiently as possible?
  • Would your customer base absorb a price increase?
  • Is there an opportunity to decrease costs from suppliers?

Growth:

  • Is there a market to grow your business?
  • Do you have the capacity to grow?
  • Can you expand your service offering or hours of operation?
  • Are there other channels though which you could sell your products?

Execute some “easy hits” and start to see the value of your business grow.

Develop plans to mitigate risk, which might include widening your customer base, diversifying suppliers, training your successor and cross-training others on staff.

Benchmark your performance against others in the industry and develop a plan that has your business operating at the top quartile of your peer group within a year or two.

If you are wanting to transition your business in 3 – 5 years, consider growth strategies which are consistent with your desired risk and profitability targets.


Kelly Deis is president of Soundpoint Consulting. She earned an MBA at the Wharton School, and offers services as a Certified Valuation Analyst and Certified Exit Planning Analyst. 

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