Use this tip, learned from Zebras, to increase the value of your business
One of my kids’ favourite animals right now is the zebra. Did you know a zebra’s stripes help it avoid being eaten? When a herd of zebras is fleeing from a lion or other predator, the mass of stripes blends all the animals together, making it hard for the lion to pick one individual animal out from the crowd.
Interestingly, the same thing can happen to people and their businesses. Have you ever heard of “paralysis by analysis”? This happens when people have too many options. We tend to think about the options for too long, resulting in an inability to decide. While the thought processes behind not being able to pick may be different from person to person, the underlying factor is human – we are scared of making the wrong choice. This happens to lions too – their success rate during a hunt is only 25%. But the lions keep trying, otherwise they will go hungry. To improve their success rates, lions will go after easier targets – young or sick zebras that cannot escape so easily.
What does this have to do with business valuations? Well, like the herd of zebras, we can come up with lots of ideas on how to improve your business’ value, but it can be hard to pick just one or two key ones to act on.
In order to help us break this down, we need to focus on what is essential. To understand how to increase the value of a business, we need to know what makes up that value. Simply put, the value of a business is a measure of the business’ future cash flow, and the risk associated with earning that cash flow:
Value = Future cash flow x risk
Value is also stated as:
Value = Working capital + capital assets + goodwill - debt
In other words:
Working capital + capital assets + goodwill - debt = Future cash flow x risk
Stay with me here – we’re going to identify the zebra that should be your target. Consider which parts of this equation a business owner can directly influence. Working capital, which is cash, receivables, and inventory, less payables, is not easily changed by a business. An owner can try to increase working capital by selling assets or taking on more debt, but that’s just reallocating among the components - it doesn’t really change the overall value. Similarly, the owner cannot make the business’ capital assets worth more, or reduce its debt, without impacting the other components of value.
The only thing a business owner can directly influence is goodwill. Which means any change in cash flow and risk are directly impacting the goodwill of the business. In other words, the only ways to increase the value of your business are to increase cash flows or decrease the risk. So, if you are analyzing ideas on how to improve the value of your business, think – does this idea increase future cash flows, or reduce risk to a buyer? If it doesn’t do either, then it’s not going to increase value.
For more inspiration on increasing the value of your business, check out what you can learn from the 'Baby Shark' song.