Everybody reading this article has one common goal for his or her business and that is how to make it more profitable. This article will discuss some of the common value drivers of a business and how small changes can have a big impact on your bottom line.
Keep Good Books
Being a small business owner you may have the attitude that this is my business and I can basically do whatever I want (within reason of course). This often includes running personal expenses through the business. This allows the business owner to minimize taxes, but could be an expensive decision in the long run. For example, let’s say over the course of a year you run $25,000 of personal expenses through your business. Hypothetically, this reduces your net income from $75,000 to $50,000. This saves about 20% off your federal tax bill, or $5,000. You feel pretty good about this, but consider the consequences. On the personal front, this decision could affect your ability to qualify for a mortgage, get better interest rates, etc. On the business front, this decision can affect the future value of your business when you put it up for sale. Let’s look at the business aspect further.
Let’s say you are ready to sell your business. You go through the sales process and you sell your for 3x Seller’s Discretionary Earnings (SDE). In the example above, you reduced your net income by $25,000. If you sold at 3x SDE, that just cost you $75,000 in the value of your company.
In the short term, you were able to reduce your taxes by $5,000, but by doing that you essentially reduced the value of your company by $75,000 in future value. Is it worth it? You make the call.
What are you charging for your product or service? Should you raise or lower your price to positively impact the bottom line? The answer is “it depends”. Like everything else in business it is not that simple. The first thing you need to consider is your market. How does your product or service stack up to the competition? If you have the infrastructure in place you can lower your price and drive your completion out of the market. For most, pricing the competition out of the market is not an option. This approach is what the Middle East Oil Cartel is doing with the price of oil. Nobody expected the price to drop below $50 a barrel from a price that was hovering around $90 a barrel. They have deep pockets and the reserves to attempt to drive the U.S. oil shale producers and those smaller producers involved in “fracking” out of business.
As mentioned earlier, the majority of small business owners operate from a place where their price is their price and they can’t gain market share and more profits by pricing the competition out of the market. What other alternatives are there? You can increase your pricing by a small amount, say 5%. This will positively impact your bottom line, without significant negative impact to your customers. For example, say you are an auto mechanic and your billing rate is $150 an hour. A 5% increase would change the customer’s bill from $150 to $157.50 an hour, most people would be willing to pay that small increase per hour. What does that do for you as a business owner over the year? If you charge an additional $7.50 per hour x 40 hours a week x 52 weeks a year this can increase your profits by $15,600 per year, per mechanic. That can make a big difference to the bottom line.
Now if your objective is to sell this business let’s look at the impact of this 5% price increase. Again, let’s say your business sells at a ratio of 3x Seller’s Discretionary Earnings (SDE). That 5% increase of $15,600 x 3x’s SDE = $46,800 added to the value of your business.
You can see how small changes can have a very big impact when you look at the big picture.
Now assume you make both changes in your business practices. You would now add an additional $121,800 to the value of your business and your nest egg. All of this is possible and becomes achievable if you are able to measure the value of your business and establish procedures to review your company’s progress. It all starts with a baseline appraisal of your business. With this initial appraisal you will receive an assessment of the company’s health and what steps should be implemented to build the business you want and a future you can count on.
For more information on how to build a solid future with your business call Matt at Analytic Business Appraisers at 480-857-7449. It all starts with knowing what your business is worth today!