Your company’s focus on aggressive revenue growth has paid off. You scored that big government contract and are well on your way to a banner year…right? That depends. Many a business has generated a strong revenue stream only to kill profits and significantly drain cash flow–and ultimately drain the value of the company.
Beware that there’s more to building a valuable company than revenue alone. Without a balanced financial perspective, rapid revenue growth may actually decrease your company’s value. It’s time to balance your perspective and know your numbers.
Revenue and Profit
Revenue volume will generate a number of things that drive market value for your business. The two most prominent items are measures of profitability: EBITDA and backlog (for future EBITDA). There are other levers to establishing your company’s value and the quality of your business, but all owners should know their EBITDA and outlook EBITDA. The market’s key value indicator of enterprise value is a multiple against EBITDA (i.e., profitability), not simply revenue.
- EBITDA (earnings before interest, taxes, depreciation, and amortization). This calculation shows the efficiency of your operations before the influence of accounting and financial deductions. EBITDA may be adjusted for non-recurring items such as one-time expenses, owner-specific costs or operational costs that will not recur in the hands of a new owner. In other words, these “add back” costs will go away when the company is transferred to the new owner.
You are naturally focused on ways to be more market competitive and win contracts. Have you considered the impact a win will have on your indirect cost rates? A rate impact assessment can provide an outlook to understand how your new revenue will affect the rates you can propose in the future. You will need to tie in proposing competitive bid rates with rates that also generate attractive profit.
We met one company that was excited to have won three prime contracts in a row and wanted to sell. However, in looking at the business, the bid wrap rate (combined indirect expense markup) barely covered fringe costs, let alone produced significant EBITDA. This is the tie into profitability— in this case, there was none, and it dampened the value of the company even with the contract wins.
Cash Flow and Taxes
Plan for the cash you need to fuel your growth, as well as to accomplish tax planning. Is your business classified as a cash-basis taxpayer? That means you report income in the year you receive it and deduct expenses in the year you pay them off. [Companies that use the accrual method report income in the year they earn it, not receive it, and deduct expenses in the year they are incurred.] As a cash-basis taxpayer, you may also be able to stay designated as a small business in a certain NAICS code longer.
Companies may have an incentive to make investments before the end of the tax year to reduce the income on which they are taxed. Before you implement such a strategy, consider how it will affect your cash flow and anticipate the line of credit needs well in advance. Know your DSO (days sales outstanding), monitor your outlook and line of credit needs and assess how they will change by running various business scenarios.
Don’t surprise your banker. And don’t be surprised with an unexpected tax bill! We like to brief bankers and owners throughout the year and start tax planning mid-year. Tying tax strategy, cash flow, and indirect rate impacts into your overall corporate strategy will maximize the value you are generating in your company.
These measurements that go beyond revenue—and there are many more—demonstrate a key concept for a profitable operation. No one metric gives you the whole picture. Track a variety of measurements, get a 360-degree view, and maintain a balanced perspective.
CAVU has a number of monitoring tools and dashboard perspectives to keep you visually in tune with this balance and drill down on your business metrics. We can help you understand the value drivers of your different lines of business.