Every business broker and professional advisor will tell you that you need to improve profitability if you want to increase the value of your business for sale.
But where do you start and what process should you use? You look around your business and everything looks like it is running efficiently and you think you are doing a good job – so why would you think that you can easily increase the level of profits?
When you are running a business, you are consumed with the day to day operations and fixated on getting business in the door to cover the payroll.
Rarely do you ever sit back and take the time to systematically review your business operations with a view to increasing profits incrementally. But this is what it takes to lift overall profitability – not the big bang, but little steps which gradually improve the overall productivity of the business.
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Nor are you expected to know everything about how to do it. You may have attended a few seminars, heard some interesting speakers or even undertaken a degree program in management. But when it gets down to a list of things which you can do – for some reason the information is hard to find. In some cases it is worth bringing in a consultant, but only do so when you can see where they can make improvements – that is, have a good idea of where an improvement can be made even if you don’t know exactly how to go about it yourself.
This chapter is not a silver bullet for increasing profitability but will guide you to where you might find some nuggets. What I am going to set out here are some common approaches to expense reductions, revenue increases, process improvement, better asset utilization and more productive use of personnel which can help you build a roadmap for your business improvement. Some will not be applicable because you are already doing a good job, others won’t apply due to the industry you work in but some will open your eyes to new techniques.
It does not matter what works, as long as some do. The end result should be a lift in your overall profitability and that will then be multiplied several times into your business valuation.
My approach is to do the simple things first and then tackle the more complex changes later. The list will cover the following:
- Increase revenue
- Clean up the business
- Follow the Money
- Benchmark your business
- Undertake process improvement
Most approaches to increasing profit focus on cutting costs and some of these techniques will be explained in this chapter, however, by far the most effective and certainly the most rewarding approach to increasing profits is to lift revenue through an increase in marketing and selling expenses or greater productivity of current sales and marketing resources.
A focused approach to revenue generation which examines systems and processes in marketing and sales will almost certainly uncover areas where improvement can be made. Many smaller businesses simply do not take advantage of the productivity tools now available for sales force management, customer relations management or lead tracking, yet significant increases in sales force productivity can be gained with the application of technology.
Research into high growth businesses has shown that they typically spend more on selling than marketing, focus on creating excellent customer experiences and generate a significant part of their new sales through referrals.
They also have very high recurring revenue through both increased usage and cross selling. The lesson here is obvious – to what extent are you working your current customer base and what is the untapped potential under your nose?
Recurring revenue can be increased through longer term purchasing agreements, quantity price discounts, loyalty schemes, more frequent and personal contacts with customers, engagement of customers in business events and so on. Cross selling can be increased by introducing complementary products and services. Improving customer relationships should have a knock on effect on referrals.
By examining how sales resources are used, you will often find that sales staff are spending too much time on administration and this time can be better used if additional systems are introduced or additional administrative support provided. Where sales staff are overworked, additional sales staff can often greatly improve the productivity of existing staff.
Increasing recurring revenue and referral sales has a knock on effect on valuation. First, it can increase the profitability of the firm but, more importantly, it can increase the reliability of the revenue forecasts. As forecast revenues becomes more reliable, the discount rate used in business valuation decreases thus significantly improving the valuation of the firm.
Clean Up the Business
It is always easier to sell a tidy house. Sometimes it is as simple as putting things away, getting rid of the rubbish, mowing the lawns, trimming the trees, fixing the broken gutters and presenting the house in the best possible light.
Some of what you are doing is temporary but other things you do will have a long-term effect. The same logic applies to your business. There is nothing wrong with making the place look good and there is a lot you can do to make it more efficient.
Think about some of these activities:
- Sell old and unused equipment.
- Remove rubbish, broken equipment and unwanted files.
- Rent out unused space in the office, warehouse and factory.
- Stop paying for activities which don’t contribute to your business.
- Remove your personal expenses from the business.
- Outsource those things which can be done better and cheaper by someone else.
- Consolidate operations which use too much space or resources.
- Rent out unused car spaces.
- Renegotiate your bank fees, volume discounts, telephone charges and other recurring fees.
- Sell obsolete inventory.
- Reduce loans with surplus cash to reduce interest costs.
- Eliminate loss making product lines and loss making services.
- Sell or lease out surplus land.
Sometimes we just need a reason to look in all the cupboards and behind all the doors to see just how much we can save by doing the obvious.
Follow the Money
A very simple process for prioritizing where you should look for savings is to rank all your expense lines from the largest to the smallest. Too many people look for savings in things which are obvious but insignificant in the big picture.
Thus saving 10% of the fax paper bill is peanuts compared to 10% off the payroll or manufacturing supplies. Once the items are ranked, start at the top and look for ways in which each expense can be reduced.
Ask the following questions:
- Is this necessary?
- Do we need to do it to this extent?
- Could we do it better?
- Could we achieve the same outcome with fewer resources or at a lower cost?
- Could someone else do it better than us for less expense?
- Where can we find out about how to do it better?
It is often simply a matter of attention. When an activity is not under scrutiny it tends to become less efficient over time. Don’t try to do everything at once, just take them one at a time and work at it. Also, don’t try to solve every problem yourself, involve other people in the process. You will be surprised what a little bit of collective and creative thought can do for generating ideas for improvements.
You don’t have to improve each item by much to generate an overall impact on the bottom line. But remember that the change you make has to be sustainable.
Taking costs out of the business which will have a detrimental effect long-term will undermine your valuation, not improve it. Whatever changes you make should be documented and you should be willing to justify your changes to an informed buyer.
Benchmarking is a process of comparing your operations with other similar businesses, with best practice in your industry and with world-class companies.
The purpose of benchmarking is twofold, it allows you to identify areas for improvement and it provides you with a strong and defensible case for changes which you make to improve your profitability.
Benchmarking can be used on both revenue and expenses. By reviewing the marketing and sales productivity of similar businesses, the firm may well be able to readily identify ways of generating additional revenue from its existing resources.
Often firms find it easier to generate additional revenue than cut costs as there is a limit to how far costs can be cut before the fabric of the firm is undermined.
The key to any change is to be able to show that you made the change in such a way that the long-term impact is positive and sustainable. Any change you make which you cannot justify on the basis of common sense or using an external standard is going to come under investigation. If it can be shown that the expense reduction was made simply to ‘window dress’ the business, the buyer might withdraw, considerably increase the due diligence effort looking for other instances of manipulation or simply increase the discount rate. A short-term gain could result in a significant drop in the value of the business.
A precondition to using benchmarking techniques to improve your business is that you need to implement metrics or performance measurement within your business in order to measure your performance against others. So the first thing you need to do is work out how you can measure performance across the entire company. In the initial phase, you do not need to set targets, you simply need to implement reliable measurements. Once they are in place, you can then begin to examine each one to see what improvements can be made. In some cases it will be obvious, especially those which have unreasonable fluctuations.