The Business Valuation as an Incentive Management Tool

valuation_bannerWikipedia defines a business valuation as a process and a set of procedures used to estimate the economic value of an owner’s interest in a business. A valuation or appraisal is the means to determine the price transacted to affect a sale of a business.

A significant tool in building business value should be to annually measure its value. So true and often said is: if you can’t measure it, you can’t manage it! Small business value is determined by the ability of the entity and its management to generate cash income after all expenses for the benefit its owners. Business value is then a prophesy of the future as a basis to project cash flows, subject to specific inherent, economic and non-controllable risks. A business appraiser will value the projected cash flow and measure the risk of not achieving that projected owner benefit. The risk is determined and considered as part of the development of a return of capital rate applied to a future benefit stream.

Factors that affect future owner benefit risk are indeed plentiful. They cover:

Some inherent risks encompass the type of industry in which the entity operates, competition, entity leadership, business management, ease of market entry by competition, technology and innovation, product obsolescence, scalability, patents, trademarks, copyrights, strong branding, and all other known or knowable events affecting the risk that the entity will fall short of its projections.

Some economic risks relate to inflation, money supply, interest rates, employment, strikes, housing, tax policies and all other known or knowable events affecting the risk that the entity will fall short of its projections.

Other non-controllable risks that may be considered are natural disasters, war, disease, global warming, severe weather patterns, only some of which may be of some level of concern and because of location(s) of entity.

A professional business valuator will answer pointed questions and provide a benchmark for enhancing growth.

Besides monitoring value growth, such enhancement may be considered for incentive compensation plans. What can be better resource to set goals for the senior management team than that which results in the entity building value? And some of that enhanced value can be incentivized to motivate the team.

Once a baseline valuation is established, annual updates should be relatively efficient.

I you have any questions.or would like to discuss this topic further please call GKG and speak to our valuation professionals.