Part Two: Building Value is a Process–Increase Net Cash Flow

Dear Clients and Colleagues:

Last month, I shared Part One in “Building Value Is a Process.”  We discussed the three principles of valuation and the three general approaches to valuation.  We concluded that for closely held companies, the Income Approach is often the preferred method of valuation.  Under the Income Approach, maximizing value becomes a function of increasing net cash flow, decreasing an investor’s perception of risk or a combination of both. 

This month, in Part Two, we’ll focus on various ways that Stevenson Valuation Group can help you, the business owner, increase net cash flow…

        Net cash flow is usually used as the measurement of owner benefit because it is net cash flow that is actually available to pay dividends. 

        The primary determinant of what a buyer will be willing to pay for a business is the future cash flow that the buyer expects to realize from the business.  In fact, the single most important factor in closing a sale is the buyer’s belief that future net cash flow will continue to grow, thereby, increasing the value of the business.

        To increase cash flow, Stevenson Valuation Group can help you focus your activities on cash management and profit maximizing techniques. Examples of some of those techniques follow: 

·         Create a cash flow forecast. 

            In essence, we’ll work with you to set goals equal to your definition of success and then back up your plans with achievable monetary benchmarks.

·         Collect accounts receivable fast. 

        The goal is for you to be the industry leader in collections. By decreasing your collection period can loosen up a surprising amount of cash.

·         Don’t over invest in inventory.

        We’ll help you analyze the movement of inventory with a focus on removing slow moving, cash consuming items.  And, we’ll  help you calculate the savings of reducing the your           Company’s average inventory days.

·         View disbursements as investments. 

        Having an outside view of expenditures helps identify disbursements not paying dividends. We can be that objective voice.

·         Maximize your gross margin percentage.

        Similar to the point above, cost of sales is an investment that is measured by your gross margin percentage.  Too often businesses accept the gross margin     percentage as an end result rather than managing it for a desired outcome.

·         Take care of your employees. 

        A well designed employee incentive plans improves productivity and cash flow.

·         Minimize taxes. 

        Stevenson Valuation Group will take the time to help you understand your basic tax framework and work with your tax advisor to minimize the tax impact of increasing your profit.

·         Invest in technology.

        If your Company is not using the latest and most efficient technology it is losing ground   in the market place and value is leaking out.

Of course, every business is different and the actual steps to improving the cash flow of your particular Company will be specific to your Company.  What’s outlined above are general ideas and should not be considered an all inclusive list.  Stevenson Valuation Group considers each client a unique opportunity requiring a tailor – made strategy for meeting specific goals. 

Please call me so we can discuss and set in motion a plan for you to maximize value.

Next month we’ll discuss how Stevenson Valuation Group can help you analyze and reduce an investor’s perception of risk and the impact of risk on your Company’s value.

If you have any questions about this blog, please don’t hesitate to contact me.

Sincerely,

Thomas G Stevenson, CPA, CVA

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Building Value Is A Process

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Building Value Is a Process

Part One of a three part series.

 Part One

The process of building value in a company starts with a basic understanding of how value is determined.

There are three appraisal principles that constitute the foundation of valuation theory. These principles are (1) the principle of alternatives, (2) the principle of substitution, and (3) the principle of future benefits.

The principle of alternatives states that in any contemplated transaction both buyer and seller have choices and do not necessarily need to enter or proceed with a proposed transaction.

The principle of substitution states that value tends to be determined by the cost of an equally desirable substitute. In other words, if two items are identical, except for price, a willing buyer will gravitate to the item with the lower price. Or, in terms of an investment, if two investments have equal risk an investor will invest in the item that provides the greatest return.

Finally, the principle of future benefits tells us that economic value reflects anticipated future benefits. Basically, there are three reasons that investors will invest in a certain stock: (1) dividends (future cash flows to the investor), (2) capital appreciation (future cash flows to the investor upon sale), or (3) a combination of the two.

Since there is no ready market for closely held stock, an experienced valuator, keeping in mind the three principles above, will analyze and examine a vast array of information before selecting an appropriate valuation method or methods. The valuation method selected will fall within three general approaches:

Asset Approach

Market Approach

Income Approach

 In the asset approach emphasis is placed on the current value of the assets less liabilities. It is typically used for companies with volatile or low earnings, holding companies, companies that will soon be liquidated and capital intensive operations. It does not provide a value for goodwill which must be computed separately if it exists.

The market approach employs the valuation principle of substitution. The substitution theory states that similar assets have similar values. Therefore, by comparing the subject company to other comparable companies a reasonable estimation of value is obtained. The market method is a highly regarded method for valuing a going concern because value is derived directly from the marketplace. However, finding suitable comparable companies is extremely difficult and often time consuming.

For profitable, non-public companies, the Income Approach is often favored. The income approach measures value based on the principle that the value of a business is equal to the present value of the future benefits of ownership. The benefits of ownership are most often expressed in terms of net cash flow. The present value factor is usually referred to as a capitalization or discount rate and is generally considered to be a measurement of investor risk expressed as a percentage.

The income approach employs a simple formula to determine value:

Value = Benefit/Risk

 Therefore, maximizing value is a function of increasing net cash flow, decreasing risk or a combination of both.

Next month, in Part Two of this article, we will discuss ways to increase cash flow and minimize investor risk.
Sincerely,

Thomas G Stevenson, CPA, CVA