Month: September 2017

Preface: In business, journaling is useful for gathering data that can be applied in the future too. If you understand the purpose of reflections about business, and the value of working on your business, and not always in it, you’ll do well to read and apply the Harvard Business Review advice from January of 2016.

Investing to Double Your Businesses Value – Part VIII

Credit: Donald J. Sauder, CPA

Investing to Double Your Businesses Value – Part VIII is not about history being written in Word documents with auto saved features; it’s about you, having the opportunity to reflect on, and write, your own history.

Let’s reflect for a moment on a Harvard Business Review article from January 2016, that outlines the value of advised journaling in business leadership:

Research has documented that outstanding leaders take time to reflect. Their success depends on the ability to access their unique perspective and bring it to their decisions and sense-making every day.

 Extraordinary leadership is rooted in several capabilities: seeing before others see, understanding before others understand, and acting before others act. A leader’s unique perspective is an important source of creativity and competitive advantage. But the reality is that most of us live such fast-paced, frenzied lives that we fail to leave time to listen to ourselves.

Connect to purpose. All too many leaders have a surfeit of opportunities but suffer a paucity of meaning. Asking questions that bring us back to what is most meaningful to us personally, as well as to what we believe is most important for society and the planet, deepens our sense of purpose. For example, you might ask: What is my daily work? What is my life’s work? Similarly, reflecting in your journal on inspirational words from world leaders or wisdom traditions can act as an antidote to superficiality and parochialism

Gaining access to your own insight isn’t difficult; you simply need to commit to reflecting on a daily basis. Based on research (my own and others’) and many years of work with global business leaders as a consultant and international management professor, I recommend the simple act of regularly writing in a journal: 

https://hbr.org/2016/01/want-to-be-an-outstanding-leader-keep-a-journal

Journaling your business’s history as it unfolds, helps you see, understand and act before other entrepreneurs. It also, helps you understand yourself, your business and your marketplace. When reflecting on your business journal, you could quietly say; Hi! Stories of my Business! A journal helps you step back to avoid risks, and reflect to make more successful decisions in the future. A journal helps you navigate a common denominator or say numerator. Shifting from reactive business, to proactive business, requires the ability to see, understand, and act first.

One of my favorite stories is Rob McEwen, CEO of Goldcorp in 1999. McEwen was leading his company on discovering additional deposits at the Red Lake Mine in Ontario. In his search for inspiration from a demand for immediate exploration results, McEwen didn’t spend more time working on the business problem himself; instead he took some time to reflect, and traveled to MIT where he attended a lecture about open-source software systems.

Minutes after the lecture, he got an idea that worth billions. Applying a contrarian and vanguard approach, McEwen launched the Goldcorp Challenge. Sharing proprietary geological data with the public, he created a contest with a $575,000 cash prize: present exploration plans and techniques on where to find gold in Red Lake based on the data. Resource findings and results would award the winners. Millions of entries were submitted, within weeks, from mathematicians, graduate students, and experienced geologists. More than 100 targets, all hidden beforehand, were identified. The idea resulted in 8 million plus ounces of gold reserves; and a substantial world-class discovery.

In the minerals and mining business, exploration is for the purpose of gathering data that will be useful in the future, e.g. resource and reserve harvesting. In business, journaling is useful for gathering data that can be applied in the future too. If you understand the purpose of reflections about business, and the value of working on your business, and not always in it, you’ll do well to read and apply the Harvard Business Review advice from January of 2016. In 2014, did you journal where you’d be in three year? A thanksgiving and reflection are advised if that answer is yea.

Investing to Double Your Businesses Value Part VIII – Investing time to reflect on the past, and the present, while writing today your future business history.

Preface: Looking at your business through the eyes of prospective buyers, while working to double business value will likely improve profitability, (while you still own your company), and help you locate area’s that can increase value from a better understanding of how value is created, sustained, and successful transferred, i.e. doubled.

Investing to Double Your Businesses Value – Part VII

Credit: Donald J. Sauder, CPA

Exit planning for life after business, is a pillar to successful business strategy. Only the best of the best entrepreneurs get it right. You’re advised to exercise a plan to think about exit planning early for your business from the perspective of prospective buyers, even if you have only been in business a few years. It’s a necessary step to double business value, not to say managing your business like a great entrepreneur.

Exit planning usually is accomplished with a sale to family or a third-party, i.e. key employee. It is more than signing on an articulate will, or grooming a family member successor. The sooner you start planning a business exit, the more options, and opportunities your business will hold to harvest optimal value, and transfer business wealth successfully in an ownership succession transfer. Planning your exit from a business requires more thinking through a buy/sell agreement with an advisor, or obtaining continuity insurance. Although some entrepreneurs think exit planning is only necessary if estate or trust planning are required to effectively distribute business wealth, effective exit planning in the scope of doubling business value, is strategizing your business from the perspective of potential buyers.

In a third-party sale, you can have an enterprise sale or partial sale. A partial sale typically will result in the entrepreneur continuing to own from 80% to 20% of the business equity. Exit planning is often advised three to five before retirement, or a succession transfer, but the best entrepreneurs will plan the exit early, before it is even necessary. At least half of entrepreneurs exit their business unplanned; i.e. they haven’t prepared there business for a second generation life.

In addition to value creation, you should think about exit planning strategy early because people count on your business, e.g. if you’re a manufacture for a business, and a major source of vendor supply, your business should feel a responsibility to not domino problems for the business chain because your materials or services are not easily available elsewhere. Transition and exit planning is not self-centered, it’s responsible business; because transition risks are relevant not only to you, but your customers and clients too. Good entrepreneurship should advisedly include strategies to reduce exit risks to valued customers or clients.

Don Feldman, Sage advisor at Keystone Business Transitions, LLC in Lancaster, PA, has the following advice for entrepreneurs with regards to exit planning:

When valuing a closely held business, I frequently pose the following question to the business owner: what do you think the business is worth without you?  A similar question can be asked in regard to key employees:  what is the business worth without your key employees?   If they are critical to the success of the business their possible departure represents a risk to the business.

……The more difficult problem is when the owner is “key” to the business and can’t easily be replaced.  We see this most frequently when the current owner was the founder of the business and retains the principal customer contacts or the “know-how” essential to the business.

This situation is a good example of why, when I ask the business owner “how much is the business is worth without you” the best answer is “it doesn’t matter if I am running the business or not”.  This means that the business will have just as much value in the buyer’s hands as it does in the seller’s and it is relatively easy to sell the business.    However, we are frequently presented with a situation that is not ideal. The art of the exit planner is to be able to develop solutions that will work in the “non-optimal” case.

https://keystonebt.com/2016/09/key-employees-are-key-to-your-exit/

The purpose of planning or strategizing what your business exit plan is before beginning the doubling of value to your business is advised for two reasons, 1) Intrinsic business value is only realized tangibly with a successful exit from ownership; and 2) You need to understand what will encompass that value at exit, e.g. tangible assets; or intangible assets.

Looking at your business through the eyes of prospective buyers, when working to double business value will likely improve profitability, while you still own your company, and help you locate area’s that can increase value from a better understanding of how that value is created, sustained, and successful transferred.

Part VII of Investing to Double Your Businesses Value – think through your business exit plan today, from the eyes of prospective buyers.

Preface: The value of a business is often associated with the future value the business will add to its customers or clients, in its geographic marketplace. That value is a reflection of cash flows, net income, and asset values. A business valuation applies a fair market value assessment of that value contribution to the marketplace from a valuation model approach, i.e. the science; and adds the art of deal.

The Science and Art of Business Valuation

Credit: Donald J. Sauder, CPA

“Price is what you pay, value is what you get,” a famous Warren Buffett quote, is certainly most applicable to business valuation. Purposes of a business valuation, from setting value for buy/sell agreements, to obtaining bank financing for an acquisition, alternative financing, or exit planning in a transition, a look at what a business valuation process encompasses should be helpful for entrepreneurs.

Business valuation is both an art and science. With the science of the process and set of procedures applied to a valuation approach 1) Asset approach; 2) Market approach; 3) Income approach; and an art applied to the normalization of company activity, say with a controlling interest. There are as many specific values for a business as there are valuation experts, because business value means different things to different people. For investors, the value is based upon cash flows; for a strategic bidder, e.g. a vertical integration purchase, a business value is determined from consolidation metrics, or market share advantages. The circumstances surrounding the valuation report is part of the art, e.g. exit planning for retirement, relocation, or partners joining.

Albert Einstein is quoted as say, “Try not be a man of success, but rather try to be a man of value. This is true for business valuations too. A business valuation is not a success because the business value is the highest stretch, the valuation is a success because it is objective, independent and a fair market value; and a value achievable in a public marketplace bid. Business value, while both an art and science, is not saying that valuations reports should have substantial ranges in value; while each is unique and different, good valuations should be similar. Price expectations for a professional report usually include a value appraised for a fair market,

 

• i.e. fair market value: the price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arm’s length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts. {NOTE: In Canada, the term “price” should be replaced with the term “highest price.”} as define in Statement on Standards for Valuation Service No. 1.

 

The approaches to valuation are the methods for determining a business value. The Income approach include a profit multiplier or capitalization of earnings based upon normalized earnings of business. This approach is often used when a business has stable cash flows from year to year, and earnings or cash flows can be weighted for a number of historic year financial performance. The cash flows or net income can be multiplied or capitalized at either a pre-tax or after-tax performance metric. For an investor, it is important that your valuation use an after-tax approach. Why? You are purchasing the business for profit generation, and those profits will be taxed. Therefore, you must account the after-tax cash flows either for ROI (return on investment), ROE (return on equity), or credit financing repayments.

 

Another income approach is the discounted future cash flows. This method is often used for companies with variable earnings or variable cash flows, and requires the preparation of financial projections for discounted earnings of financial performance for a determined value, i.e. what is the value today of $1,000,000 of future cash flows in the next 10 years? The excess earnings method is a third income approach that applied an intangible and tangible rate of return on business assets, with multiple calculation metrics.

 

The asset approach is not based upon income or cash flows, but the net value of the business. This would be most applicable to real estate partnerships say, where the asset is most the business value.

 

The market approach to valuation, applies comparisons of other marketplace transactions to guide values. This approach required the valuator to access comparable market transactions, i.e. a BIZCOMPS or IBA Market Data, and compare similar size business transactions. The market method is subjection to differences to location, and management performance that influence appraised value. For instance, 10 business transactions with a value determined with the capitalization of income approach would result in 10 data points for the market approach BIZCOMPS sale price data. The subjective factors in those values would ultimately influence the market approach of a discretionary earnings multiple or multiple of revenues.

 

NACVA Standards have two types of value. A calculation of value and a conclusion of value. A calculation of value simply calculates and documents a calculation of a business value and is often a report between 18 to 34 pages. A conclusion of value requires economic and industry analysis and additional steps of documentation for the appraisal conclusion. A conclusion of value is often a report more than 50 pages required to appropriately document the business appraised value. Conclusions of value are required for litigation and compliance-oriented engagements, i.e. tax matters, e.g. gift tax compliance or estates.

 

“The value of an idea lies in the using of it.” Thomas Edison’s words could be rephrased for business valuations to say, the value of a business valuation lies in its marketplace relevance. The value can be modified annually from shifts in economic circumstances or transactional circumstances. The valuation report documents why that value is defensible, fair, and accurate.

 

In summary, the value of business is often associated with the future value the business will add to its customers or clients, in its geographic marketplace. That value is a reflection of cash flows, net income, and asset values. In a competitive market, there are few competitive advantages, and therefore, the businesses are somewhat comparable, e.g. the method or model consistently applied accurately determines appraisal value of the business. A professional business valuation applies a fair market value assessment of that value contribution to the marketplace from a valuation model approach, i.e. the science, and adds the art of deal.

 

 

 

Preface: Comparing your financial data to industry benchmarks may confirm strengths your business has in its sector or locale, and reveal areas for improvements. This blog is about tracking your business pulse with financial industry information.

Business Health Checkup

Credit: Jake Dietz, CPA

Is your company healthy? This question could be hard to answer. Even if you know your financial numbers, ratios and percentages, how do you know if they are vibrant? Different industries and fields have their own sets of benchmarks, or standards for comparison. For example, a 30% gross profit margin might satisfy entrepreneurs in one industry, but it might disappoint entrepreneurs in a separate industry. How can an entrepreneur or manager know if a business’s numbers and percentages are good? Compare your numbers to industry benchmarks to reveal strengths and identify weaknesses and then work to improve necessary areas.

Comparing your data to benchmarks may confirm strengths your business has in its sector or area. For example, suppose the industry benchmark is 30% for selling, general, and administrative (SG&A) expenses, but your SG&A expenses are only 20%. That indicates you run a leaner, more efficient operation than your competitors. That strength may help you weather a downturn that could put some out of business.

When you see your data beside an industry benchmark, you might also see where your company is weaker. For example, suppose the industry benchmark for gross profit percentage is 30%, but your gross profit percentage is only 15%.  Assuming your overhead is the same as the industry benchmark, then you need to sell much more just to make the same net profit percentage as the industry because your gross profit percentage is below the benchmark. A good time to call a financial physician? The company is not fulfilling its full potential, even if it manages to sell enough to be profitable. Good accounting is important in making these financial assessments.

Not only can benchmarks reveal weakness in profitability, but they can also reveal weakness in other areas, such as liquidity. Liquidity refers to a company’s capability of paying its liabilities in the short term. A company’s current ratio can be compared to the industry current ratio. A current ratio compares current assets (available within a year e.g. cash and accounts receivable or inventory) to current liabilities (payable within a year, e.g. accounts payable, accrued expenses or debt). If a company’s current ratio is much lower than the industry benchmark, then the company may struggle with cash flows to pay its bills.

It can be exciting to see how your company compares to the industry, but the greater benefit is to act on the information. If a weakness can be detected while it is still small, then you may be able to avoid a major problem. Look for ways to improve on that weak area. If the current ratio (current assets compared to current liabilities) is too low, can you keep more cash in the business instead of distributing it? Or can some expensive asset purchases be financed with a 3 year note instead of the line of credit? Perhaps a big change isn’t necessary, but small tweaks could help. Maybe some less necessary expenses could be minimized. On the other side, maybe revenue could be increased. The company may have certain types of work that are less profitable. If so, consider doing less of that work or charging more for it.

Comparing your company to a healthy industry benchmark may not automatically improve a company’s performance, but it allows the entrepreneur to see strengths and weaknesses and then adjust the company’s path accordingly. Applying industry and benchmark information to your company improves performance. Talk with your CPA for a business health checkup.

Preface: As you advertise your business, think of it as planting seeds. Plant your seeds on good ground, be diligent because you don’t know if it will be a 30, 60 or 100 fold crop; harvest at the right time, and then sell your crop at the right price.

Advertise Your Business for Success

Credits: Jake Dietz, CPA

Good advertising is like planting a small corn seed in good ground. A small seed planted now may later yield a bountiful harvest. Advertising wisely can increase sales and strengthen your business, but advertising poorly can waste your money and hasten business failure.  Before you advertise, develop a plan to track advertising success, close the sale, and monitor your prices.

Track your business as it comes in your door. If a customer calls, find out how they learned about you. Did they see your newspaper advertisement, did they see your truck driving down the road, or did they hear about you from a satisfied customer? Don’t waste precious dollars on useless advertising without knowing if it works. Track which advertising brings in the customers, and develop a strategy for advertising that targets those who will buy your products and services.

Advertising might get customers interested, but it may not be enough to close the sale.  Advertising is planting the seed, and closing the sale is harvesting. A bumper crop benefits the farmer after it is harvested. Is everyone on your staff that communicates with customers trained for sales? Everyone who has contact with the customer should know how to help close the sale, whether they sit in the office or fix sinks at the job site.

If a rude person answers the phone, or doesn’t offer helpful information, then the customer may go somewhere else. A customer might want something that you offer if they only knew you could do it. The technician or estimator on the job site can spot opportunities to better serve the customer. Never force a customer to buy something they don’t want, but inform them of the options. If a customer is asking to have a wooden deck built, do they know which options you have for decking other than wood?   Do you also offer deck lighting?

Selling products is great, but not when the price is wrong.  A bumper corn crop might be a great disappointment to a farmer if the corn price was only 20 pennies per bushel. Do you know what your costs of doing business are, not just the costs of the products you sell? If you buy a pipe for $9 and sell it for $11, then you just made $2. Or did you? Is that $2, along with the other profits, enough to pay employees, pay rent, and keep the lights on? If the prices are not high enough to meet costs, then advertising and increased sales may cause the business to fail faster. Monitor your prices so they cover your costs and earn a profit.

As you advertise your business, think of it as planting seeds. Plant your seeds on good ground, harvest them at the right time, and then sell your crop at the right price. This scenario benefits farmers and businesses. It takes work, but the harvest for your business can be worth it.