Enhancing the value of your business is primarily the process of stabilizing and growing your earnings stream. The investment world calls this “quality of earnings,” which simply means that the earnings are stable and predictable, i.e., devoid of large fluctuation from year to year. Earnings of this type are less risky for investors, will support higher levels of debt (if and when such are needed or desired), will put more money in investors’ pockets over time, and therefore will garner much higher valuation. Add consistent growth to the equation and value increases exponentially.
Whether you and your family continue to own your business for the next 100 years or plan to sell it in a few years, you’ll reap considerable financial benefits from enhancing the quality of the earnings stream. Doing so is not easy, of course, but by breaking down the task into project-size initiatives and tackling them one at a time, before you know it you’ll have strengthened your business considerably and raised value substantially.
Here are some value-enhancing strategies to consider:
Sell Value, Not Price: If you are competing for customers based on price, you’re likely not making much money. You must find a way to add more value, real or perceived, and charge a premium that garners far higher profit. One way to accomplish this is to develop your own proprietary products. If they have value to customers and nobody offers them but you, you should be able to charge a healthy price.
Price Strategically to Maximize Profit: There’s a strategy to getting the most profit from a product and product family. There’s also a strategy to pricing quantity orders. Read the case study “Use Cost-Volume-Price Analysis to Increase Profit” in this issue and “Strategies for Maximizing Profit Throughout the Product Life Cycle” in the next issue of The Business Owner Journal.
Diversify Your Customer Base: What would happen to profit if you lost your largest customer? If the answer is anything but “not much,” then you have a customer concentration problem that adds risk and volatility to your earnings. You need to work on bringing in new customers and building existing ones. Many customers purposely turn away the big boys and focus on the little guys. Big guys have lots of power and everyone competes for their business. That means lower profit margins. Add to this the diversification risk, and you may be better off being less of a lemming.
Diversify by Industry: The economy as a whole is cyclical, but individual industries swing more wildly than the overall economy.
To stabilize your earnings stream, you need to serve multiple industries. To achieve growth, penetrate growing industries.
Diversify by Geography: The global economy is also cyclical, but individual locations don’t move in lockstep. In fact, they ebb and flow at different rates and times. If you serve a single geographic area, your earnings stream will depend entirely on the fortunes of that single economy. By penetrating other locations, you will insulate yourself a bit from local swings and smooth out your earnings stream.
Diversify Your Talent Pool: People drive businesses. In your case, you hope that more than one or two people drive your business. What would be the impact if you fell ill? If your partner or personal assistant went to work for a competitor? The prudent business owner will address risks such as these and work to diversify his or her productive talent pool and/or mitigate risk associated with a particular employee. After all, the inevitable will happen — it’s just a matter of time.
Product Mix and Diversification of Gross Profit: Individual products and services will have good months and bad months, good years and bad years. They also have a life cycle that, as with every life cycle, eventually leads to the pasture. To smooth earnings and always have fresh horses ready to carry the load, develop a diversified line of products and services that includes a steady flow of new entries.
Off-Balance Sheet Risks/Contingent Risks: Risk and uncertainty will lower the value of any business because eventually the inevitable will hit and earnings will suffer. So whether the contingent risk is a lawsuit (which can be mitigated by insurance), a real estate lease (which can be mitigated by buying the property or moving locations in advance of the inevitable), or a key supplier deciding to “go direct,” it will serve you well to address the issue today by working to lower your exposure rather than hoping Murphy’s Law will give you a pass.
Go for Less Cyclical or Countercyclical: The general economy rolls through periods of high and low growth in cycles that average eight years. Some industries are more sensitive to cycles than others. Generally, construction and capital equipment industries and those that depend on them are the most volatile. Companies that rely on these industries will experience earnings volatility and receive lower valuations. Other highly cyclical industries include: personnel supply (e.g., employment agencies); computer services (e.g., custom software creation); agricultural services (because of the landscaping and horticultural component), automotive services (such as car rentals and repairs); miscellaneous repairs; luxury goods; travel and lodging industries; personal services such as laundry, cleaning, and garment services; and motion pictures. Health care services are the most countercyclical, gaining jobs rapidly during an economic downturn. Other industries generally believed to be countercyclical, or at least far less sensitive to general economic downturns, are private education, child day care, amusements and recreation. Expand into these industries and your earnings will be less volatile and the value of your business will increase.
Lower Costs: Obviously, every business must continually wring out cost. Every dollar saved is another dollar earned. Develop a lower cost base than your competitors, and you can run ‘em out of business or enjoy more profit than they do on every sale.
Reduce Fixed Cost in Favor of Variable Cost: All things being equal, in a world of uncertainty, variable costs are much more suitable than fixed costs. Variable costs are much lower risk and generally offer lower variability of earnings. So look for ways to economically trade fixed costs for variable, such as finding independent contractors to do certain tasks when needed and that will only charge for when they are used. This, of course, instead of hiring a full time employee (for example) to do the job and running the risk of not being able to keep that person productive and 100% utilized.
This article originally appeared in The Business Owner Journal, the periodical of choice for owners of small and midsize private businesses. All rights reserved, D.L. Perkins LLC. © 2012.
This publication is intended to provide general information on the subject matters covered. It is sold and distributed with the understanding that neither the publisher nor any distributor or advertiser is engaged in providing legal, tax, insurance, investment or other professional advice. The advice of a qualified professional should be sought before any reader applies a concept presented herein to his or her particular situation or business.
D.L. Perkins, LLC is solely responsible for this content.
