Question: I’m curious to learn more about business valuations. Should business owners seek out business valuations only when they are planning on selling, or should this be done regularly for informational purposes?
A: Although it may be obvious that your business is successful and has value, many business owners aren’t exactly sure what their businesses are worth. The products or services you provide are meaningful to your clients. Yet, if someone asked you, “How much is your business worth?,” could you confidently provide a quantitative answer?
In our experience, we have seen many business owners overestimate the value of their businesses, based on rules of thumb, comparing themselves with other similar businesses that have recently sold, or by a simple “gut feeling.” Sometimes, albeit less commonly, owners undervalue their businesses for the same reasons. One thing is clear: Failing to know what your business is worth right now can have negative consequences for your business and personal goals.
- Growth planning. A business’ value can be indicative of how well (or whether) it’s growing. While factors such as gross sales and cash flow play an important role in determining business value, they aren’t the only factors. For example, if the cash flow results from two or three big clients, potential buyers most likely will reduce the value the business due to the risk of large losses if one of those clients leaves following a sale. Likewise, if you, as the owner, are the primary reason for strong cash flows, a potential buyer may reduce their assessment of the business’ value to reflect the cost and risk associated with your eventual absence. Even if you never intend to sell your business, its value is primarily based on what qualified buyers would be willing to pay for it.
In short, knowing what your business is worth right now – as a consequence of what you’re currently doing – can help you determine which areas of your business can improve to allow you to pursue your growth goals. Growth relies on numerous factors (value drivers), some of which aren’t as obvious as cash flow. Awareness of the value drivers will allow you to implement strategies to potentially increase the value of your organization, which can help guide your business toward the growth you desire, regardless of your own personal exit plans.
- Personal planning. When we advise our clients related to business transition, succession and exit planning, we encourage them to begin the process with an understanding of the value of the assets they have today. This means getting their arms around the value of their business, which is often the largest asset they own. We then discuss what they will need and want in the future, after tax , to invest in order to generate the cash flow they require to live the life of their dreams, such as traveling, hobbies, philanthropic initiatives, wealth transfer, etc. We then determine if a gap exists in current value of assets compared to with future needs and wants. If a gap does in fact exist, growing the value of the business is the strategy that will generally be the best way to fill the gap.
- Time for planning. Growing business value to a point at which you can achieve your goals can take years. It’s rarely as easy a flipping a switch or making a small change, yet many business owners severely underestimate how much time it takes. Knowing what the business is worth now helps you determine how long it may take to build the business to where you need it to be.
It’s important to understand the value of your business so you can best lead your team in the future. If you are interested in learning more about business valuations, reach out to a trusted CPA, business or financial adviser or valuation specialist so you can be as prepared as possible for your future, and for the future of your business and employees
Crystal Faulkner is a Cincinnati market leader with MCM CPAs & Advisors, a CPA and advisory firm offering expert guidance and beyond the bottom line thinking for today’s public and private businesses large and small, not-for-profits, governmental entities and individuals. Tom Cooney is with Wealth Dimensions, an investment advisory firm. For additional information, call 513-768-6796 or visit online at mcmcpa.com. You can listen to Tom and Crystal daily on WMKV and WLHS on “BusinessWise,” a morning and afternoon radio show that profiles highly successful people, companies, organizations and issues throughout our region.