Business Value as a Tool

by Donald W. Nalley, Jr., CPA, CVA, ABV, ASA
Owner and Director
Beason & Nalley, Inc.

Recently I spoke to the local Leadership management academy class. I was asked to speak on general business valuation concepts, but wanted to leave the class with at least a couple thoughts or ideas they might be able to use in their business career.

The idea of utilizing business value as a real management tool, not just a compliance issue, is one of those ideas. What do I mean by that? The concept is easy enough to grasp. The difficulty comes in execution, or making it real.

Let’s look at “value” as it relates to the value of a company. Value is an exchange concept. Value is, by definition, the price point at which a willing buyer and a willing seller would agree to an exchange. A value set too high by an unrealistic seller not fair market value because the price is set at a point higher than a buyer would realistically agree to. The reverse holds true for a buyer offering a price too low. It might help to think of value as that point where neither party is very happy; both sides feel a little pain. Obviously that feeling of pain will vary, but rarely will both parties feel like they walked away with a steal. It happens, yes, but not often. So the point here is: be realistic and do a good job of estimating value. Estimating value of 1 times revenue is a widely held fallacy by too many companies, especially in the government contracting market. For small companies, and especially those with set-aside work, using some industry wide assumption is more likely than not an unrealistic price expectation.

A second concept that we all need to understand in order to grasp value as a management tool is this: Value is simply the present value of future cash flow. “Future” is the key word here. Any prediction, by definition, is a probability analysis. The odds are very great that something different than predicted will occur. The higher the predictability of future cash flow, the higher the value. Predictability is a projection concept, fraught with “what ifs”, contingencies, and issues, both internal and external. We sum up this future filled with issues as a basket of risks. Those risks are external and internal. Most companies can do little with the external risks, but they can impact the internal risks. That’s where great management, training programs, client relationships, IT systems, quality product/services, etc. all impact value. In other words, the better the systems and processes are in a company, the more predictable future cash flow, i.e. inherent internal risk is lower - all enhancements of value.

With these two basic concepts in hand, we can form our postulation that any company can use business value as a tool. The first step would be to establish a realistic initial value. We suggest getting professional assistance in setting a realistic value. Starting with a realistic expectation makes future discussions fairly straightforward and basic. The second step is the process of beginning to run the businesses in a way that enhances the value components on both a current and long term basis. Think of it this way: business value can be the best long-term indicator of the health of a company. I can think of many cases where profits were still ok, but the dynamics of the business said that the future of continued prosperity were in decline. So profits might have been good, but with inadequate R&D, poor financial infrastructure, lack of employee training or career paths, the value needle indicated a very real problem. There is probably no other single measurement that I know of except “value” that provides an analytical indicator of the intangible strengths or weaknesses of a company. When that indicator points down, change may be required, and quickly.

Let me know your thoughts. I’m sure there are companies out there that are tracking value as a management tool.

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