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Is there a direct relationship between profits and your business’s value?

dreamscape

20-02-16

A couple of weeks ago a client told me that they always assumed their business’s value was based largely on the profits it made.

Hmmm.  Not so fast I replied, or words to that effect.

This thought sparked a conversation about the myriad large and small factors that can effect a business valuation. And clearly the financial state of the business is one of those.  However, other factors such as timing,  the fit with a potential buyer, the quality of the staff, the market positioning of the business ; there are endless other factors.

Coming back to the financial performance of the business, there are ways that a business could improve its headline profits, yet actually make itself less appealing to a buyer.  For instance what if the business owner specifically refused to take on a management layer to run the day-to-day issues of the business, thereby saving costs and increasing profits?

All micro-businesses owners (and many who run medium-size businesses too) will recognise the classic hub-and-spoke structure:

Every client transaction, complaint or staff query comes through the hub (that’s you!).  The hub-and-spoke manager controls their business with all the key decisions centralised at the hub.  But they have just created themselves a job for life, and while they might have saved some expenses, they have just reduced the likelihood of anyone wanting to buy the business, at whatever value. If you remove the hub, you risk making the business worthless.

Conversely, reducing profits by taking on management and supervisory staff could actually increase the value dramatically because a potential buyer will see the opportunity for the business to carry on running without you.  And almost by the way, between now and when you sell the business, it will probably make your working life easier too.

As always, it’s a tricky balance and one which I’m always to help you unravel.