Many times I find myself having to handle the difference between how business owners view the value of their business and how investors would view the value of any business. Investors would base themselves on detailed, quantitative valuation models on which they would base themselves before making any investment decision and at what price. Surprisingly many business owners are not fully in-tune with such quantitative valuation models, meaning that many times their decisions are not always working in favour of increasing the value of their business.
So I believe it is important that I outline the key drivers of any business valuation. I believe it is important for business owners and management teams to keep a constant watch on these drivers to allow themselves to compare their performance in the industry. These drivers can also help business leaders understand the changes in how the value of their company and the value of other players in the market is changing over time.
So what are these key drivers:
- Growth in company revenue (present and forecasted)
- Growth in gross and net profit margins (present and forecasted)
- Track Record and Forecast of Dividends paid to shareholders
- The company’s debt-to-equity ratio
- The economic conditions in the company’s industry
- The track record of proven competence by Ownership & Management to implement proper corporate governance and efficient management structures.
Not surprisingly, revenue and margin are generally the two most important key drivers that companies can control, though not always in a uniform and balanced manner. There is obviously an element of seeing these drivers in the context of the industry one operates in. There are industries that are driven primarily by revenue, while there are other industries driven mainly by margin. For example, the hotel business relies heavily on margin.
Keeping a close eye on these drivers helps business managers and owners understand how the valuation of their business is changing over time. It could be that in past years, the valuation of your business was much more margin and hence internal oriented. The pandemic and the external factors it brought with it changed all this,whereby external factors are now likely even more important key drivers to the value of your business. The implications of this shift can be surprising. It is likely that in a post-pandemic business environment, with higher inflation rates, the importance of profitability margins becomes secondary to defending your market share and hence revenue growth.
It is a common mistake that business owners and management team, focus on key drivers that was driving the valuation of their business some two or three years earlier, or in some cases much longer. The reality is that it is not possible for businesses to be agile without good data and analysis.
So keeping a close eye on the key drivers effecting the value of your business and how your competitors are performing on these key drivers, helps you understand the changing relative importance of these key drivers to your business and to your competitors and adjusting your strategies accordingly, in good time.