Driving Value Creation
Measuring the value of your business is key to successful continuous improvement
BY RICK BAUERLY
In thinking about the importance of your business's value, here's a little food for thought from an expert on the matter, Warren Buffett. He said, "It is better to buy a great company at a fair price, than a fair company at a great price."
As managing partner of Granite Equity Partners, Rick Bauerly leads the firm's operations and investment activities. Prior to his leadership role at Granite Equity, Bauerly
worked for a variety of companies including Deloitte & Touche, Bauerly Companies and Venture Allies, a management consulting firm he founded in 2000. Bauerly graduated with honors from Saint John's University where he studied Economics and Management. He later received a Masters
in Business Administration from the Harvard Business School and a Masters in Public Administration from the Kennedy School of Government at Harvard University. He has served on the Board of Dezurik Water Controls, the Centracare Health System, and the Anderson Entrepreneurial
Center, and is a past president of the Saint John's University Alumni Association.
At Granite Equity Partners, we abide by the old adage that what gets measured gets improved. In helping companies to increase their value, we first consider their current value. From a purely economic point of view, value is measured by taking the present value of the company's
expected future cash flows, discounted at the relevant cost of capital. This detailed analysis is the cash view of a business, or how a professor of finance might think about a business's value.
The shorthand method is what we call the EBITDA Multiple method. EBITDA stands for Earnings Before Interest, Taxes, Depreciation and Amortization. That is, earnings before interest payments to a bank, earnings before taxes paid to the government, and earnings before
depreciation and amortization, which is a noncash expense listed on your income statement. It's a rough proxy for the operating cash flow of a business, independent of how it's financed and how much interest a company may be paying to a bank, independent of taxes that all businesses
pay, and independent of how much capital is being reinvested. Taking EBITDA times a certain multiple--between three and eight for most businesses, with many falling in the five and six range--and you get Enterprise Value, which is synonymous with the total value of a business.
From a numerical standpoint, value can be created by improving seven operating variables: the variable of scale, or how fast the top line is growing; margin improvement, or the ratio of EBITDA to sales; tax efficiency, or the ratio of tax to sales; working capital
acceleration, or the ratio of accounts receivable plus inventory to sales; net asset efficiency, or the ratio of sales to fixed assets; financial leverage, or the ratio of debt to total assets; and EBITDA multiple expansion, or the subjective and judgmental "price" that a buyer
uses to value the business.
But metrics that build value also reach beyond the tangible to guiding principles that can be established throughout a business. Perhaps the greatest asset a company can have is that of exceptional leadership. While businesses might spend more time thinking about things that
can be factored into a capital budget, bringing in the right leadership is essential. It's also important to align incentives across all business stakeholders, particularly the owners, directors on the board and executive managers.
Third, a business should support an environment of continual learning. The companies we govern are active in management education and development forums, which we've found can lead to ideas, decisions and actions that can increase value.
The fourth principle is incorporating strategy into the governing principles of the business. If a management team meeting is entirely about last month's financials, they may not see the risks on the horizon, or be able to outmaneuver the competition.
The final principle, fostering a culture of measurement, brings us full circle. By measuring value, the drivers of value, and key operational success factors, a company continually improves, benefiting its leadership, employees, customers, stakeholders and the community in
which it operates.
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