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Musings on business value, sale preparation, sale negotiations, sale structure.

Archive for Oct, 2013

Neat valuation trick

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Business value is not all about taking two metrics and multiplying them together. For sure the final calculation always boils down to this simple idea, but the real skill in valuation is establishing the metrics to be used. One tool which we use, is the concept of momentum.

In the real world, momentum is the velocity of an object, multiplied by its mass. If you passed school physics with more than 30%, it may be something you remember. Momentum is also the difficulty one has in stopping something. Stopping a goods train going at 10km/h is a very different matter to stopping an Atos at 100km/h.

Think back a moment, if you will…. to when your last set of financials were given to you by your accountant or auditor, or whomever. I’m almost certain that one of the comparisons you made was recent sales turnover to last year’s sales turnover. Some would have expressed this as a percentage, and compared it to some inflation index.

But almost nobody will compare it to earlier years, or draw any meaningful conclusions. So here is a handy tool.

It is a small Excel spreadsheet with no macros. You use it like this:

  1. Only fill out the white spaces.
  2. Put in the name of your company, or some reference
  3. Decide whether your company has a February year end, or some other month
  4. Decide which year to use as your starting date
  5. Fill in the data from your financial statements. I use only the thousands, and I don’t bother to round up. It is not that sensitive. So if your sales turnover is 37,563,785-98, I would only put in 37,563.

This is what it will show you:

  1. What you are doing, is relating everything back to the first year, and expressing the result as a percentage. We call this an index.
  2. The line at the top of the graph when you finish, has been your historical top performer. Hopefully it is one of either your net profit before tax (NPBT), or your gross profit (GP).
  3. The least favourable result is to have the expenses curve at the top. This would mean that your expenses are outstripping your income. It is unsustainable.
  4. The steepest line in any one year represents the greatest growth in that year.
  5. The point in a line which is at the top at any particular year shows that up until that point, that element was the best performer.
  6. Having expenses as your best performer is not good.

Opportunities and threats in technology

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How much is your business threatened by technology?

Some businesses are still running remarkably well on spreadsheet based accounting, simply because they run very few invoices each month. Most of the invoices are quite big, which is another valuation headache all over again, but not for this blog. I have a client from whom I bought a product last week, and was amazed to see him write out an invoice in an old triplicate book!

For the most part though, businesses now run on Pastel or some other accounting package, if for no other reason than to easily be able to put their books together at the end of each month, and at the behest of the accountant. But this is not the kind of technology I am on about here.

For some businesses, real valuation risk lies in the exposure a business has to technology movement. Some years back CellC jumped ahead with new 900 megawotsit technology, able to provide very fast connectivity at a very cheap price. The others were left standing, bogged down in the rejuvenation cycle. But now it is their turn, as CellC amortises its equipment, and the others leapfrog ahead with LTE technology, ready for the newest phones. This industry has an exposure to cutting edge technologies. So do many others, and the risk lies in not being able to finance the investment required to keep up with competitors or alternatives.

Bedding and furniture manufacturers, and most retail operations don’t stress about this stuff. A decade back, machine shops were all being challenged with new computer driven lathes, able to work faster, with less waste, more accurately than a hand operated lathe. Not so much any more. Those that were turning by manual control have all disappeared. Today it is the norm to have the machinery driven by a computer generated drawing, drawn somewhere away from the machine, and possibly simply on file.

3D printing is becoming more and more effective every month, now. It may not yet be mainstream, but it is becoming more effective, and quickly so. New materials are being used to print with. It is now possible with a relatively cheap 3D printer, to print a semi automatic rifle and fire it repeatedly. So how does this technology affect your business? You may currently have an edge in a big bank balance and the ability to import a container load of widgets for sale over the next six months, while your smaller competitor struggles with stock, or even buys from you. How will you react when it is no longer necessary to hold all this widgetry inventory?

What happens when your business also becomes a corner printer shop? Your customer will order from a catalogue, and then wait for you to deliver the freshly printed mouse trap. Suddenly the value of the business will not be in the stock, the suppliers and the retained earnings. It will be the same place as software developers – the drawings, the innovation, the programs. It will all be about intellectual property. Leverage will be more about what employees can conceive, what marketers can attract and what service a business provides to its customers.

So again:

  • How exposed to developing technologies is your business?
  • What opportunities do developing technologies present for your business?
  • How quickly do you have to change?

Those are questions, the answers to which are going to make a huge difference to the value of your business in the next five years. It does not apply only to the 3D printing of machine parts, but also web based technologies, fuels, lubricants, optics, audibles, foods, electronics, computing, communication and so much more.

Did I mention that the labour component is going to fall away as the biggest spend and headache? Does that mean that China will be less of a threat?