The year end is upon us. Business owners will soon be reviewing 2013 and laying plans for 2014.
Most will be thinking in terms of sales, gross margins, profits, cash flow or growth and how to increase those metrics. Few will be thinking of business value, its measurement and its growth.
This is unfortunate since the key economic measuring stick is value.
Why is value so important? It’s easy to understand the importance of value when an owner is nearing retirement, is burned out or has other reasons to think about exiting his or her business. However, exiting is a distant future event for most owners, or at least they think it is. The current reasons for thinking in value terms are seldom recognized or understood. Few realize that managing from a value perspective will increase profitability and cash flow while reducing risk.
Let’s think about your investment from a value point of view. Notice I said investment, not business. Your business is an investment. Wise investing calls for a return on investment (ROI) commensurate with the risk involved in making the investment. Of course, there are more reasons than money for being in business for yourself. There are the psychic rewards: the feeling of freedom, of being your own boss, your self-image. Those important rewards do not diminish the need to consider your investment and how it is paying off. It’s easy to total up your financial investment. However, if you are going to consider the intangible returns of being in business, objective thought requires thinking about the intangible investments – stress, long hours, forgone or reduced salary compared with what you can earn working for someone else, loss of yourself as a whole person, and the risk that your investment will not pay off, that you will lose both your tangible and your intangible investments.
If you think you should consider the value of your investment or at least learn how value managing can bring current rewards, here are some beginning steps. Take financial statements or tax returns for the last five years and calculate your ROI. The simplest way is to divide profit by equity. Most business analysts agree that 20 percent is an absolute minimum ROI for small- or medium-size firms. Risk considerations will probably require that you have a higher return. Ask your accountant or banker for the average ROI for your industry as shown in Risk Management Associates (RMA) data. Ask yourself two questions: First, is the ROI where it should be? And second, is the trend consistently upward? If either answer is no, you have some work to do.
If you pass this first test, go to step two by adjusting your P&L and balance sheet to realistic numbers. Consider whether such expenses as rent paid to you, your salary and value of assets are at market value. Make any needed adjustments and calculate the adjusted profit. Now recalculate the ROI and ask the same two questions suggested above. If your ROI is below the economic market rate, you are taking excess risk with your investment.
While you are at it, calculate some additional value related ratios such as return on assets (ROA), inventory turns, labor cost and debt to equity. Your accountant can help you with these calculations. Again, compare your results with the average for your industry. Use your calculations to set goals for 2014.
Think about using value as your measuring stick. It will pay off in many surprising ways.
Bowser@BusinessValueInsights.com. Dan Bowser is president of Value Insights, Inc.
