Insights Into Financial Management: Scorecard For Success

Adrian Loud

June 1, 2008

T here is no single “value” of a company. It changes over time and is subject to many influences, including economic and industry outlooks, company-specific attributes and motives of the buyer and seller.

But the theoretical way to quantify value is to estimate the company’s future cash flows and discount them to the present using a rate of return commensurate with the riskiness of the company.

Expressed as a formula: Value (V) = Cash Flow (CF) / Rate of Return (R) – Long-term Growth Rate (G)

Ownership interests in closely held businesses can change. Gifting, death, public offering, divorce and other reasons drive transfers of businesses but the end-plan is typically a sale or succession plan.

The question business owners must ask, is, “Am I doing everything to maximize the value of my business for an eventual transfer?” Most business owners are too focused on the day-to-day operations to worry about preparing for a prospective transfer.

Buyers may adjust earnings to better estimate cash flow. The required rate of return differs from buyer to buyer, but should reflect chances of realizing the estimated cash flow, returns generated on similar investment opportunities and long-term growth opportunities.

So how does the business owner maximize value? Based on the formula, the owner should try to increase cash flow, reduce the risk associated with realizing the cash flow, and substantiate strong growth expectations. Here are the factors that go into accomplishing this:

Balance Sheet
This is the company’s financial backbone. There must be sufficient assets to operate. Furthermore, are receivables collected timely? Is there a reasonable level of inventory? Are payables handled promptly?

Financial Statement
Smaller companies keep internal financial statements while larger companies should consider compiled, reviewed or audited financial statements.

Income Statement
This is the starting point for the numerator in the formula. It also is useful for measuring performance from one period to the next. Some of the favorable metrics sought by buyers include stable or increasing profit margins; controlled operating expenses; minimal non-operating and extraordinary income and expense items; and no owner manipulation.

Growth Trends
Growth trends in income statement and balance sheet fundamentals catch a buyer’s eye immediately. A company with a history of steady revenue and income is worth more than a company with flat or declining trends.

Comparing Yourself To Others
Does the company run smoothly? Is the corporate culture healthy? How does the company stack up against its peers?

Leadership
Solid management manifests itself in many ways. The owner is no longer indispensable for periods of time. Employee morale is high and turnover is low. The income statement improves every year, and management is properly incentivized to perform at a high level and stick around long-term.

Roadmap To Success
A current, well-organized business plan articulates where the company has been and where it is going. Financial statement projections and supporting narrative about how goals and objectives will be achieved helps buyers and other parties better understand the business, and encourages management to hold itself accountable.

Ownership
Ownership may be too centralized or decentralized. It is often appropriate to gift shares or contribute shares to charities in an effort to minimize estate taxes. Conversely, if there are several unrelated shareholders who provide little or no benefit to the company, it may be prudent to repurchase those shares.

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Adrian Loud is a senior manager at Bennett Thrasher. Listen to Bennett Thrasher's biweekly financial management podcasts at www.btobmagazine.com.

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