With all our talk about small business owners and their retirement plans, hopefully we’ve kicked you into gear to think about your own. We’ve looked at a few of the issues and why it’s so important. If you’re like most entrepreneurs, your small business is the biggest asset in your portfolio.
Not to be dramatic, but the value of your small business basically controls the rest of your life. It determines not just the quality of your retirement life, but also when you’re able to kick back. As small business accountants meeting the needs of clients in the Greater Toronto Area, we can’t stress enough that to make sure our clients’ business grows at a pace that meets their retirement plans, they need to perform regular business valuations.
It’s critical for small business owners to understand how the value of their business is determined. To do that, you need to know the particular drivers that let you achieve maximum business value.
A business’s value is ultimately determined by its ability to generate future cash flow. The most common method for regular business valuations is to estimate future cash flows, while looking carefully at what may happen down the line to impact them.
In some industries, an asset-based approach is the way to go. Real estate companies are a good example. But even here, the real estate’s underlying cash flow is what mainly determines property value.
Often small business owners hear about rules of thumb in their particular industry. Those include the idea that selling value is a multiple of annual sales, size of customer base or gross profit contribution. Keep in mind these methods are really just substitute indicators for underlying factors that determine future cash flow.
So how do you figure out future cash flow? There is no exact business valuation formula, as each and every business is going to be different.
Here are a handful of the biggest factors to look at: industry and market trends, available management, strength of brand, unique relationships with suppliers, patents and trademarks and proprietary technology.
You need to perform regular business valuations to find out whether or not your business’s growth is consistent with your plans. What you learn in the valuation will also help you decide whether changes need to be made in business strategy, planning and development.
Defining your key business drivers through the valuation is a benefit. As an owner, when you lay those out and understand them, you can incorporate that info into your business strategic plan. That helps build future growth and profitability.