Industrial Automation Companies

Beyond the Multiple: How Profitability Impacts Value

Posted on March 13, 2023 by

Bryan Powrozek

Bryan Powrozek

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Valuation Screen with GraphIf you are a business owner curious about the value of your business, you probably already know that one method of determining it is to apply a multiple to your pre-tax profit, also known as your Earnings Before Interest Taxes, Depreciation and Amortization (EBITDA). Once this method is learned, many owners become obsessed with determining and driving up their multiple. However, that is only half of the equation. 

Profitability is Half of The Equation 

Every business works hard to improve the profitability of their operations. System integrators tend to focus on optimizing their project management, reducing costs and diversifying their service offerings. 

Optimize Project Management

Integrators can improve profitability by optimizing their project management. This involves creating a project plan that outlines the scope of work, timeline for completion and resources needed to complete the project. By managing projects more efficiently, system integrators can reduce the time and cost required to complete each project. This can lead to higher profitability on projects as well as increase the number of projects completed within a given period. 

Optimize Operations

System integrators can also reduce costs by optimizing their operations. This can involve finding ways to reduce the cost of hardware and software components, negotiating better deals with suppliers and optimizing their workforce. By reducing costs, integrators can improve their profit margins and remain competitive in a crowded market. 

Diversify Service Offerings

Finally, profitability can be improved by diversifying their service offerings. By expanding into new markets or offering additional services to existing markets, a system integrator can attract new customers and increase their revenue. This could involve expanding into new geographic regions, offering new services such as post-installation support or cybersecurity, or partnering with other companies to offer bundled solutions. By diversifying their service offerings, integrators can reduce their reliance on a single source of revenue and create new opportunities for growth. 

But, Profitability is Open to Interpretation 

When an acquirer evaluates a business, they typically make adjustments to the income statement to reflect their view of the company’s financial performance. Three common adjustments that can drive up a business’s value are eliminating discretionary expenses, minimizing a business’s working capital requirements and identifying redundant expenses. 

Eliminate Discretionary Expenses

Many privately held business owners make operational decisions with a focus on the tax impact and are not necessarily concerned with the impact on business value. One example of this is rent paid to a real estate entity also owned by the business owner. In certain cases the business owner may pay above market rent to the real estate entity, which makes sense given the owner’s personal tax situation. However, this would not be the case for an acquirer who would expect to reduce the rent and as a result drive up the profitability of the business. The same applies to excess owner compensation. If the owner is paying themselves more than they would pay an outside replacement, there is an opportunity for the acquirer to reduce costs. 

Minimize Working Capital

Another way to increase the value of a business is by minimizing the working capital needed to run the business. This can be done by improving inventory management, optimizing accounts receivable and payable, and reducing the amount of cash tied up in other working capital items. By minimizing working capital, the seller can show an acquirer that they will not need to keep as much cash tied up in the day-to-day operations of the business. This makes the business more valuable to potential buyers. 

Identify Redundant Expenses

Finally, depending on the type of prospective buyer, sellers can increase the value of their business by estimating the expenses that can be reduced or operational synergies that would occur after a transaction. For example, if the company is being acquired by a third party with a building large enough to accommodate all employees, any costs associated with operating the current office can be reduced. There are also potential synergies between the two companies that could make completing work more efficient. Both of these will result in decreased expenses and increased profitability over what the business was capable of on its own. 

The key to successfully making these adjustments is to be able to defend your case for each adjustment. You need to make a good case for how profitable your business will be in the hands of an acquirer. The process of adjusting your profit is part art and part science, and it can be challenging to know where to start. However, by working with an experienced business broker or M&A advisor, you can identify areas where adjustments can be made and develop a strategy for presenting these adjustments to potential acquirers. Even if you are not looking to sell your business, it is still important to understand these adjustments and the impact they can have on the overall value. 

Continue the Conversation 

Profitability plays a larger role in determining business value than you may think. If you would like support determining the value of your business, we can help. Reach out today to learn how our new Growth Accelerator service can help you maximize business value.  

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Bryan Powrozek

Senior Manager, Industrial Automation

As the leader of the firm's industrial automation group and host of The Sound of Automation podcast, Bryan helps owners free up cash flow and scale their businesses.

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