What are Valuation Drivers?
Business valuation is the assessed worth of a business in monetary or material terms. It depends on the perception of the future business potential of the business. And it also speaks of what should be expected of it in the coming months and years. Valuation drivers are the forces that help in business value creation and increase its worth in both the short-term and long-term. This is more of a quantitative term that is measured with the help of financial statements, return rates, and future prospects of the business. Valuation drivers are more qualitative in nature. They help to increase cash flows, reduce business risk, and enhancement of overall business value.
If the owners are looking to sell the company in the near future, they would want a good valuation for their company. It takes several years of hard work to build a new company and establish it in the market. Hence, valuation drivers become critical for achieving the best possible valuation for a company. Even if the intention is not to sell the company, these drivers are critical for the reputation and standing of the business. Also, they strengthen the company’s position in the eyes of stakeholders like banks, creditors, shareholders, etc. Moreover, the company’s shares may command a premium and get good value in the market.
- What are Valuation Drivers?
- The Valuation Drivers
- Summary and Relevance of the Valuation Drivers
The Valuation Drivers
The key qualitative valuation drivers and enhancers are as follows:
Any management that adopts a strategic positioning or the business strategy to take its business ahead is the most important and key-value driver—The business itself. Therefore, the business strategy planned and being implemented can throw light on the future road map of the business. Again, this may be for the short term and the long term. This could be concerning the growth organically or inorganically, expanding or diversifying, trading vs. manufacturing, etc. The management should know well their core competencies so as to maximize business value. A clear business strategy will help the business to gain a competitive edge in the market and make an all-around growth.
Product Lines and Mix
A company should have a wide product mix consisting of multiple product lines. This will help it diversify and not depend on a specific product or service. The loss of sales from seasonal products can be compensated with the extra sales from other products during the year. The customers also flog to the brand and company that may provide a wide variety of products under one banner. That could be belonging to the same user stream or diversified.
Large companies have many avenues to raise capital in times of need. However, the small outfits do not have such easy access to capital at will. Hence, they should be prepared to raise emergency capital if the need arises by looking into all possible channels. This will help in the adequacy of capital at all times and thus, create business value. Moreover, the business can readily work on the opportunities whenever it is available. And this will again help in increasing the valuation of the company.
Economies of Scale and Scope
After ensuring the adequacy of capital, companies have to look out for the most efficient use of their limited resources. They need to exploit the benefit of economies of scale and scope to their best possible advantage. The management should ensure that production happens at the optimum level. The cost spread among a large number of products should be proper, and the per-unit cost of those products should be the least. Also, the management should reap the benefits of economies of scope. They should produce the optimum mix or variety of products rather than just focusing on one or two items.
Economies of scale and scope will help the company maximize its gains by bringing down per unit cost and reducing wastage. Thereby helping the company to create increased business value.
Companies can create value by offering technologically-advanced products and service offerings at the best possible price. For this, the management always needs to work with an open and inquisitive mind to add or find something new. Moreover, the management needs to regularly put large sums of money into research and development activities. This ensures and avoids that the current product does not go out of fashion or become obsolete. Moreover, all efforts should be made to see that the technological advancement planned is the latest one. This should help meet the demands of customers of the new era. Of course, while deciding, the cost-effectiveness factor should also be evaluated well. Moreover, the latest technology will have the advantage of being longer-lasting, thus avoiding frequent changes.
Human resource is the most valuable capital of a company. Hence, it should constantly strive to enhance and upgrade the skills, knowledge, competencies, and expertise of its workers. Motivated and skilled human resources are powerful creators of value for any business organization. They lead to a rise in operational efficiency and higher production by reducing wastage.
The key man clause is a contractual term that prevents a company from making decisions in case its key employee is not available.
Customer Loyalty and Numbers
A large number of loyal customers with any company are the symbol of effective value creation by it. A business can succeed only if it has repeat and loyal customers since the creation of new customers is a tardy and expensive affair. Also, the company should have a diverse customer base so that the company is not dependent upon only a few customers for the bulk of its sales.
Macro-economic factors like interest rate, inflation, foreign direct investments, etc., that can directly affect a business are beyond the control of any individual or entity. Hence, the management should be ready to sustain these impacts and continue to create business value. Proper planning and implementation are essential to be ready for variations in the macro-economic factors. For example, in an adverse economic situation such as depression, a company can strengthen and use a fierce marketing strategy to keep its market share and sales numbers intact.
As discussed above, a strong marketing and branding strategy can turn the tables for any company and be a powerful valuation driver. A good marketing program helps to improve brand visibility, awareness, and recognition. Also, it improves brand recall and places a product on the top of the mind of consumers. The company gains by an increase in sales and profits, and shareholders gain by an increase in the value of their portfolio as well as increased dividends.
Long Term Vision
Most management teams continue to work on routine and make plans, budgets, etc., most for a year or so. Moreover, they remain bogged down with the routine and have no vision or idea of how they would like to move ahead or where they would like to see the company after 2, 3, or 5 years.
Therefore, this strategic vision of the management, spanning over the next 2 to 5 years, gives a sense of assurance and agility of the management to the stakeholders, investors, etc. This vision and budget plan throw light on several areas where the management can achieve synchronization, focus, and clear direction for the entire team. This, in turn, can accelerate the growth path, and the progress can be there earlier than what is budgeted.
Summary and Relevance of the Valuation Drivers
Frequent value assessment of any business gives a clear picture of where the company is standing. Moreover, whether the company has been able to consistently add value and increase its valuation. The management gets to know how successful its strategies have been. Also, it gives a chance to replan, rectify its strategy, and take care of any loopholes if the valuation is lesser than its expectations. Finding an appropriate mix of valuation drivers suiting the individual company’s needs and its eco-system and its successful implementation is a key business management exercise. And it can help the company to succeed in the long run.
One point to note is that though it looks like valuation is much more of a quantitative exercise like financial statements, future projections, multiples of EBITDA, rate of return, etc. However, actually, this is where qualitative aspects lead by valuation drivers have more impact and influence on the business valuation.