Here’s a question that every business owner should be able to answer.

If someone offered to buy your business tomorrow, how much would you ask for it?

• $500,000?
• $1 million?
• $5 million?

Or perhaps you have absolutely no idea.

You might be surprised how many business owners fall into that last category.

According to a recent Bstar advertisement, 42% of SME owners don’t know what their business is worth.

That’s an extraordinary statistic when you consider that, for many business owners, their business is one of their largest assets.

They’ve spent years, sometimes decades, building it.

They’ve worked long hours, taken financial risks, employed people, sacrificed family time and reinvested profits.

Yet many have no clear understanding of what their biggest asset is actually worth.

And that’s a problem.

Turnover doesn’t determine what your business is worth

One of the biggest misconceptions I come across is business owners assuming their business must be valuable because it has substantial turnover.

“I’m turning over $5 million a year. My business must be worth a fortune!”

Not necessarily.

Let’s look at two businesses.

Business A

• Annual turnover: $5 million
• Maintainable annual profit: $200,000
• Owner works 60 hours per week
• Business relies heavily on the owner
• Limited systems and management structure

Business B

• Annual turnover: $3 million
• Maintainable annual profit: $600,000
• Strong management team
• Well-documented systems and processes
• Recurring customers and reliable cash flow

Which business would you rather own?

And which one do you think a potential purchaser would pay more for?

Despite having $2 million less turnover, Business B could be worth substantially more.

Why?

Because buyers generally aren’t purchasing your turnover.

They’re purchasing the future earnings, cash flow and opportunities your business can generate, taking into account the risks involved.

Here’s where it gets interesting

Let’s assume two businesses each generate $500,000 in maintainable annual earnings, using the same appropriately adjusted earnings measure.

Business A is heavily dependent on its owner, has inconsistent cash flow and lacks documented systems.

A buyer might only be prepared to pay a multiple of 2 times earnings.

That suggests a business value of $1 million.

Business B has strong systems, reliable customers, an experienced management team and a proven history of consistent profitability.

A buyer might be prepared to pay a multiple of 4 times earnings.

That suggests a business value of $2 million.

Same earnings. But potentially a $1 million difference in value!

These multiples are hypothetical examples, not valuation benchmarks. Actual multiples vary considerably by industry, business size, risk, growth prospects and market conditions. The valuation also needs to account for matters such as debt, surplus cash and working capital.

But the principle is important.

It’s not just how much profit your business makes. It’s how sustainable and transferable those profits are.

The biggest risk to your business value might be you!

This might sound strange, but one of the biggest obstacles to selling a business can be the owner themselves.

Think about it.

What happens if you take three months off?

• Does the business continue operating successfully?
• Do customers continue buying?
• Can your staff make decisions?
• Does profitability remain strong?

Or does everything grind to a halt because you’re not there?

If your business cannot operate without you, you may not have built a valuable business. You may have simply created yourself a very demanding job.

Potential purchasers want confidence that the business will continue generating profits after the existing owner leaves.

If all the customer relationships, technical knowledge, decision-making and management responsibilities sit with you, that creates risk.

And risk can reduce what someone is prepared to pay.

Five things that can increase the value of your business

1. Improve your profitability
   This is often the most obvious opportunity.
   Better pricing, stronger gross margins, improved productivity and tighter cost control can all increase maintainable earnings. And depending on how your business is valued, every additional dollar of sustainable profit may create several dollars of additional business value.
2. Build a business that doesn’t depend on y
   • Develop your management team.
   • Document your systems.
   • Delegate responsibilities.
   • Build relationships between your customers and your business, not just you personally.
   • A business that can operate successfully without its owner is generally more attractive to potential purchasers.
3. Develop recurring and predictable revenue
   A business with loyal customers, contracts, repeat sales and predictable revenue can be more attractive than one constantly chasing its next sale. Buyers value certainty. The more predictable your future earnings, the easier it may be for a purchaser to justify paying a higher price.

4. Get your financial information in order
   • Would a potential purchaser be impressed by your financial records?
   • Are your financial statements accurate and up to date?
   • Do you understand your margins, cash flow and key performance indicators?
   • Can you explain unusual expenses and demonstrate your true maintainable earnings?
   Poor financial reporting creates uncertainty. And uncertainty can destroy value.

5. Have a succession and exit strategy
   Too many business owners only start thinking about selling when they’re ready to retire. By then, it may be too late to make the improvements needed to maximise value. Building a saleable business can take years. The earlier you start, the more options you have.

What could an extra $100,000 in profit mean?

Here’s something worth considering.

Suppose your business generates $400,000 in maintainable annual earnings.

For illustration, let’s assume it’s valued at four times those earnings.

Current indicative business value:
$400,000 × 4 = $1.6 million

Now imagine you improve your business operations, pricing, systems and productivity, increasing maintainable annual earnings to $500,000.

At the same multiple:
$500,000 × 4 = $2 million

That’s a potential increase of $400,000 in business value.

And you’ve also generated an additional $100,000 in annual earnings.

So improving profitability isn’t just about making more money this year. It can also help build the value of the asset you’re creating for the future.

Of course, a buyer may apply a different multiple, and the additional earnings must be sustainable. But it demonstrates why improving business performance can have a much greater long-term financial impact than many owners realise.

Don’t forget the tax implications!

Here’s another issue business owners often overlook…

It’s not just what you sell your business for. It’s how much you get to keep after tax.

Depending on your business structure, the assets being sold, your circumstances and your eligibility, there may be opportunities to access the small business capital gains tax concessions.

These can potentially include the 15-year exemption, 50% active asset reduction, retirement exemption and small business rollover.

The tax outcomes can be substantial.

However, eligibility is subject to strict conditions, and not every business or transaction qualifies.

The structure you establish today can have a significant impact on your tax position when you eventually sell.

That’s why succession and exit planning should start well before a purchaser comes knocking.

My challenge to you

I want you to ask yourself five questions.

1. Do I actually know what my business is worth today?
2. What would a potential purchaser see as the biggest risks in buying my business?
3. Could my business operate profitably without me?
4. What could I do over the next three years to significantly increase its value?
5. If I sold tomorrow, how much would I actually walk away with after tax and other costs?

If you can’t confidently answer these questions, perhaps it’s time to start looking more closely at the business you’ve spent so much time building.

The bottom line

Your business might be your greatest wealth-creation opportunity. But only if you build something that has real value beyond your own involvement.

Don’t make the mistake of spending 30 years building a business only to discover, when you’re ready to retire, that it’s worth considerably less than you expected.

And remember, you don’t have to be planning to sell your business to benefit from understanding its value.

Knowing what drives your business’s value can help you make better decisions, improve profitability, reduce risk and build long-term wealth.

The best time to start building a more valuable business isn’t when you’re ready to sell. It’s today.

How Indigo Financial can help

At Indigo Financial, we work with business owners to help them understand the financial performance of their businesses, identify opportunities to improve profitability and cash flow, and plan for the future.

Whether you’re looking to grow your business, prepare for succession, bring in a new shareholder or eventually sell, understanding what your business is worth is an important starting point.

So, here’s my final question:

You’ve spent years working hard to build your business. Isn’t it time you found out what it’s actually worth?

If you don’t know what your business is worth, contact Indigo Financial to discuss a business valuation and find out what you could do to increase its value over the next three to five years.

Because building a successful business is important. Building a valuable business is even better.

Contact Indigo Financial on (08) 8212 8585 if you need help with understanding any of your accounting, taxation and business development needs.