Business Broker Blog

Value = Increased Cash Flow / Risk

If you took an Electrical Engineering course in college, you probably remember (vaguely!) the voltage formula V = IR. Well, a good basic formula when thinking about increasing value in your company is V = I/R. V is value of course. I stands for "Increased Cash Flow" and R is "Risk". Since Risk is the denominator in our formula, decreasing Risk increases Value. Let's take a quick look at each of these elements.

When thinking about increasing cash flow the first thought that comes to mind is to increase sales. But be careful you don't go after low- or no-margin work in an effort to simply increase volume. If your gross margin dips below the industry average you will hurt your company's value. Also - watch your expenditures. Clean up your P&L and eliminate any unnecessary expenses. The most likely valuation of a profitable private company involves the capitalization of cash flow; so every dollar saved on your P&L equates to two to four dollars (or more) of value in your company.

To decrease risk you'll want to put yourself in the shoes of a potential buyer of your company. What would you want to see if you were looking at your company for the first time? First, you will want to have updated information systems, including up-to- date accounting software such as Quickbooks. Second, make every effort to maintain a diversified customer base. Customer concentrations for any single customer of greater than 25% can drag down value. Finally, make sure that you the owner are as separable from the company as possible. Train managers or key employees and delegate as many duties as you feel comfortable to these employees. A business is difficult to sell if the owner is too embedded in it.

If you do a little each day to increase the cash flow and decrease the risk of your company you will be sure to increase its value over time.