A business valuation is a process of determining the worth of a business entity, which is vital in mergers and acquisitions, partnerships, and strategic decision-making. As a business owner or director, building a high business valuation is crucial for the long-term success of your enterprise. A higher business value is not a random event or a stroke of luck but the result of sustainable business successes over time and a solid outlook for the future.
This position is not achieved in a vacuum; it is the result of hard work, smart decisions, and efficient business functions over time. In this article, we discuss 8 business functions that can significantly impact a business’s valuation in the medium to long-term and refer each function to the relevant critical component in the valuation calculation.
1. Financial Management
Financial management is the primary business function that directly influences a company’s valuation. Effective financial management practices such as maintaining accurate financial records, forecasting cash flow, and managing expenses help to build investor confidence, attract more capital investment, and ultimately increase business valuation. It lowers the risk profile in the business and provides and establishes a manner to monitor results against budgets. This lowers the risk-adjusted cost of capital (also known as WACC in a DCF valuation).
2. Sales and Marketing
An efficient sales and marketing strategy helps increase revenue and brand visibility, thereby increasing business valuation. A well-executed sales and marketing plan will help a business to penetrate new markets, build a loyal customer base, and ultimately increase profitability and cash flows.
3. Operational Efficiency
Operational efficiency is the ability to execute business operations efficiently while minimizing waste and maximizing productivity. Optimizing business processes, eliminating inefficiencies, and automating tasks lower costs and increase revenue. This results in enhanced cash inflows. If this operation efficiency is entrenched in the business operations, the long-term business value (a.k.a. terminal value in a DCF calculation) will increase substantially.
4. Innovation and Research and Development (R&D)
Innovation and R&D are essential functions in building a sustainable competitive advantage. By investing in innovation and R&D, a business can create new products, improve existing ones, and ultimately increase its market share, revenue, and long-term growth prospects.
5. Human Resources
The Human Resources function is essential in building a strong team and retaining talented employees. By creating a positive work culture, providing training and development opportunities, and offering competitive compensation packages, a business can attract and retain the best talent, leading to increased productivity and the ability to realise the business’ vision and goals. This increases the probability of achieving forecasts, thereby building investor confidence and lowering the risk-adjusted cost of capital (WACC).
6. Customer Satisfaction
A business’s success depends on its ability to satisfy its customers. A business can build a loyal customer base and increase sales by providing excellent customer service, addressing customer complaints promptly, and continuously improving products or services. This creates a sustainable competitive advantage, increasing a business’s long-term growth expectation.
7. Supply Chain Management
Supply chain management involves managing the flow of goods and services from suppliers to customers. An optimized supply chain process improves efficiency, reduces costs, increases customer satisfaction and, very importantly, reduces the cash tied up in working capital. This has a major positive influence on the cash flows generated, especially for growing businesses.
8. Risk Management
Every business face risks and effective risk management practices can mitigate those risks, thereby reducing the potential negative impact on business valuation. By identifying and assessing potential risks, creating contingency plans, and implementing risk mitigation strategies, a business increases investor confidence and lowers the risk-adjusted cost of capital (WACC).
Setting targets for these 8 business functions, measuring adherence to these targets over time, and simulating business value outcomes for different scenarios are essential in building a high business valuation. By setting targets, businesses can focus on their priorities, track their progress, and make adjustments where necessary. Measuring adherence to these targets allows businesses to identify areas where they need to improve and adjust their strategies and execution. Simulating business value outcomes for different scenarios allows a business to assess the potential impact of different decisions.