For most businesses, navigating the perilous waters of Covid has been extremely stressful and taken up all their energy and focus over the past year.
Now recovery seems underway and strong growth is forecast for the UK, it’s a great time to think about how you are going to build value in your business in the months and years ahead.
‘Rome wasn’t built in a day’, the saying goes. But it’s also worthwhile making sure it’s Rome you’re building. Are you looking to develop a lifestyle business, which generates strong cash flow and guarantees you steady income for the next 10 years? Or do you want to create value through selling your business for the maximum capital gain in a few years’ time? Either way, you should keep your eyes focused on the value creation ‘dial’ on the basis that you’ll probably want to sell your business one day.
Whatever stage or sector of business you are in, there are several key financial indicators which it’s worth watching like a hawk if you want to make sure you’re steadily generating more and more value for your business, as you move towards your exit.
Gross Margin is a measurement which experienced investors always prize highly (your profits after the costs of your goods and services sold, divided by your revenues). Your Gross Margin will largely be determined by the industry you are in. Typically, this is likely to mean high percentages for technology businesses and low percentages for those in food retail, for example.
Either way, you should always try to compare your performance against your industry sector, and aim to improve your Gross Margin steadily year-on-year. Investors understand that Gross Margin is a key indicator of value in a business. It shows your relative bargaining power both in respect of your customers (the price you charge them for your goods/services) and suppliers (the price you pay for the cost of those goods/services).
A business that shows a higher gross margin is probably able to charge higher prices than its competitors and able to secure better deals from its suppliers. This is also a strong financial indicator of many important underlying value drivers such as strength of brand, quality of management and economies of scale.
Fixed and Variable Operating Costs are another highly valued measurement for those investors who have been around the block a few times. Your Fixed Costs are those costs that you need to incur to enable your business to function regardless of whether you are running at 10% or 100% of capacity.
Think property rental costs, rates, utilities, insurance, payroll and even senior employees on long notice periods. The lower these costs relative to your Variable Costs (salaries, marketing, packaging, sales commission) the more flexible a business you have.
The ability to run a business on a minimal Fixed Cost base will protect it in a downturn and was key to the survival of many businesses during Covid. It also offers you the potential to scale up rapidly if demand for your business’ goods and services increases quickly, since most Variable Costs can be switched on and off at very short notice. This could be a route to rapid value creation one day.
Cash Collection is another measure that was incredibly important for most companies during Covid and is a strong indicator of value. This comes down to making sure that your customers pay you on time.
Monitor your overall debtor days closely (the average number of days that it takes for your customers to pay you). But also monitor your 30 day, 60 day and 90+ day debtor levels and set targets for your finance team to improve these month on month, and reward them accordingly. Keep a close eye on potential bad debts, stay close to your customers and monitor their financial performance through credit checks and any other financial analysis you can get your hands on.
Effective and improving Cash Collection is a good indicator of a well run business, which understands its customers and has the commercial skills to enforce the payments of its bills. All strong indicators of value creation.
These are of course only a few of many important drivers of value creation. However, if you can show steady improvement in all these financial indicators year-on-year, then you can be confident that you are generating value in your business. What’s more, when you come one day to sell your business, there will also be a clear and strong value growth story for your purchaser to buy into.