Key Drivers of Value in a Business

Business Advisors|Business Valuation

By John Waybright

When people think about what drives value in a business, profitability comes to mind, and it is the most important driver of value to a business.  However, there are other ways that are often overlooked.  To increase value in pure finance terms, the different levers fit into three basic categories under what is commonly known as The Gordon Growth Model:

  • Increasing the benefit stream generated (i.e., cash flows)
  • Lowering the cost of capital required to attract investors/stakeholders
  • Increasing the growth rate of the business

Increasing profitability is the most common way to increase the benefit stream, but it is not the only way.  Maximizing asset turnover or utilization also generates cash flow.  Increasing the company’s working capital efficiency will increase cash flow.  Minimizing the amount of cash tied up in the conversion cycle (receivables + inventory – payables) is also, important.  Additionally, efficient use of your property and equipment enhances cash flow.  Idle or underutilized assets tie up resources that could be better deployed elsewhere.

Optimum use of leverage is another way to increase enterprise value.  Debt is generally an inexpensive source of capital to a business, and the interest payments are tax deductible.  The proper mix of equity and debt in a capital structure generates a lower weighted average cost of capital (WACC).  A key issue to point out in regards to the cost of capital is that it is correlated to risk.  Too much debt in a business increases risk, and the cost of capital goes up. Also, not enough liquidity in a business increases risk and the cost of capital goes up.

Finally, the growth rate of the business is a key element of increasing value.  We often look at the growth rate in sales or revenue to determine this metric, but in the pure finance models, this measurement is quantified in earnings.  Therefore, growth in the top line, without a corresponding increase in earnings, is really not increasing value.

In summary, evaluating your performance in all areas that increase value in your business is important.  If you would like to know more about these areas or need assistance in valuing your business, please contact John Waybright at (614) 586-7118 or by email.

© 2014 Schneider Downs. All rights-reserved. All content on this site is property of Schneider Downs unless otherwise noted and should not be used without written permission.

You’ve heard our thoughts… We’d like to hear yours

The Schneider Downs Our Thoughts On blog exists to create a dialogue on issues that are important to organizations and individuals. While we enjoy sharing our ideas and insights, we’re especially interested in what you may have to say. If you have a question or a comment about this article – or any article from the Our Thoughts On blog – we hope you’ll share it with us. After all, a dialogue is an exchange of ideas, and we’d like to hear from you. Email us at contactSD@schneiderdowns.com.

Material discussed is meant for informational purposes only, and it is not to be construed as investment, tax, or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice.

© 2019 Schneider Downs. All rights-reserved. All content on this site is property of Schneider Downs unless otherwise noted and should not be used without written permission.