Gifts of ownership and estate planning are among the most common reasons for conducting a business evaluation for small family businesses, according to the American Society of Appraisers (ASA). However, a business valuation is helpful for many things, including:
- Providing insights into your company’s financial health and long-term viability.
- Refining marketing and sales strategies.
- Presenting a clear picture of how your market price stacks up against competitors in similar industries.
Simply put, a business valuation or appraisal determines the fair market value of your company, including any cash, tangible and intangible assets. The IRS defines fair market value as “the price that property would sell for on the open market” and “that would be agreed on between a willing buyer and a willing seller, with neither being required to act.” Both the buyer and seller must also possess reasonable knowledge of all relevant facts when determining the value of a business.
Even if you don’t have an immediate incentive for bringing in a professional appraiser, having an understanding of the factors that drive the value and growth of your company can help you strategically plan for future business needs. Here are four main areas to pay attention to when assessing the current and projected future value of your business.
1. Assess Your Company’s Financial Strength
While there are other factors that determine the value of a business, the financial strength of your company is a major one. When looking at the value of your organization, you or the professional appraiser will likely be analyzing three factors:
- The amount of cash your business generates today.
- The amount of cash (and the expected growth of that cash) your business is expected to produce in the future.
- If you have interested buyers, the return they expect from investing in and/or purchasing your business.
Your company’s financial statements—the balance sheet, income statement and cash flow statement—will be particularly helpful in presenting a snapshot of your profit margin and how your business performed over time. Pay special attention to your cash flow statement, which tells you if your company is generating enough cash for financing, investments and operations.
Look at your financial statements as a whole, not individually, so you get a complete picture of your company’s capitalized earnings, cash flow and assets. For example, your income statement provides guidance on where to invest money to increase profitability, trim expenses or delay investments in equipment. Likewise, your cash flow statement helps you figure out if you have enough cash to pay your bills on time.
2. Track Customer Growth and Satisfaction
The size and strength of your customer base are additional performance indicators you should monitor and use to ascertain your company’s value. For example, you might use the following customer metrics:
- Total number of active customers or clients.
- Total amount of sales per customer or client.
- Total number of repeat sales/customers.
- Survey results from customer feedback and customer satisfaction surveys.
As you review your customer data, keep a look out for constant trends and patterns. For instance, are repeat sales up, down or stagnant? Is your customer base growing slowly, rapidly or not at all?
Strong customer loyalty and high client retention rates help drive the value of a business. “True loyalty clearly affects profitability. While regular customers aren’t always profitable, their choice to stick with a product or service typically reduces a company’s customer acquisition costs. Loyalty also drives top-line growth,” states Frederick F. Reichheld in Harvard Business Review.
Additionally, having a diverse customer base will boost your fair market value by ensuring a large portion of your sales volume is spread across many customers. Thus, work to grow your customer base so it varies by size, geography and other characteristics to ensure long-term growth and survival.
Taking these factors into account will not only provide helpful information for valuation, but doing so also gives you insights when making decisions around market expansion. Additionally, keeping a tab on customer satisfaction and loyalty will further guide you on where and how to invest in existing customer relationships.
3. Monitor Employee Feedback and Productivity
Like your customers, your employees contribute to your company’s overall health and longevity. Your valuation should look at the number of sales generated by employees, but it should also weigh metrics on worker morale and satisfaction. Studies over time have shown that employee engagement and satisfaction positively influence productivity in an organization.
Author Shawn Achor discusses the connection between employee happiness and business outcomes in his book, The Happiness Advantage. He reveals that “A decade of research proves that happiness raises nearly every business and educational outcome: raising sales by 37%, productivity by 31% and accuracy on tasks by 19%, as well as a myriad of health and quality-of-life improvements.”
Valuation professionals consider the average length of employment and turnover rates for workers in a company, so it pays to create a supportive workplace where employees thrive and consistently contribute to your bottom line.
4. Measure the Worth of Your Intellectual Assets
A major reason why large and successful companies hold significant value is due to their investment in and development of technologies that are both unique to the market and enjoy economies of scale. Likewise, developing production methods that help your company get products and services to market quicker and cheaper than competitors will drive up the value of your company.
Your intellectual property—including copyrights, licenses, production methods, patents, software and trademarks—is an intangible asset and competitive advantage that should be considered in a business valuation. While difficult to quantify, the IRS provides specific guidelines on assigning economic value to intangible property.
Resources and Tools for Valuing Your Business
Consulting the American Society of Appraisers (ASA) or a similar professional association is the first step towards discovering your organization’s fair market value. There are numerous organizations, tools and resources for finding a qualified business valuation specialist and conducting a self-directed business valuation.