Profit doesn’t always equal value in business

Question: “My business shows a profit. In fact, it has been profitable during the economic downturn. That means it is valuable, right?”

Answer: “Not necessarily.”

I had this discussion twice in the last week with mixed results. One business did have value while the other one – not so much. Let’s dig into why.

In a blog, Lisa Kable, president of CoreValue Software, discussed this very topic. In her words, “Profit measures what happened yesterday. Value measures what can and will happen, not what happened yesterday.”

Investors look for value. Remember, you are an investor in your business. To the extent you think as a manager and not as an investor, you are missing the key point. Think about a company listed on the stock exchange, perhaps General Electric or Apple. Public companies report the financial results for all to see. The focus of the reports is profit. But do you buy a stock to see profit or to see the stock go up in value as measured by the share price? Of course, profit is one of the components that affects value or share price, but there are many more factors in the value equation.

Investors do not buy stock because it did well in the past. They buy it because they expect it to do well in the future. The near-term expectation may not include much profit if the long-term expectation is that profit will be generated in the future.

Let’s apply this thinking to your business in which you are the chief or sole investor. You are pleased that the firm showed a profit last year. However, you are more concerned with whether it will show a profit this year and, if it will, how much profit will it earn. For profit to grow, certain factors must be in place. The company must have sufficient working capital to handle anticipated growth. Management must be trained and skilled in guiding the firm. Sales, marketing and advertising plans must be revised and updated.

Equipment and accompanying processes and procedures must be tested, verified, updated and documented.

Financial reporting must be continually improved to provide needed intelligence for sound decision-making. Return on investment must be sufficient to compensate for the risk of investing in the business.

Perhaps most importantly, can the company operate without you or must you be there to make all decisions and oversee all operations? Do you think an outside investor would be interested in your business?

If you plan to exit your business with substantial cash in hand, you must make your business valuable. The future investor will not be interested in working 80 hours a week to eke out a living.

To be valuable, a business must be far beyond the survival stage. It must be a real business with real plans, real management and real value.

Don’t misunderstand. A business with profit but no real value can perhaps be sold, but the price will be low, probably much below the owner’s expectations.

If you understand and take on the role of an investor in your company, everything will change. Begin with the realization that building value is not black magic. It is a process with defined steps.

Success is not guaranteed, but your odds of achieving a real payoff improve enormously. Dan Bowser is president of Value Insights, Inc. of Durango; Chandler, Ariz.; and Summerville, Pa.