Posted by: DrAlanRae | February 18, 2009

Keeping Score – Part 1

Here’s the next extract from my e-book 20 business stories – hope you like it – You can buy it from the link on the blogroll 🙂

One of the things that you need to know is how to track the growth of value in the company; this seems one of the hardest things to get people to take an interest in. Accountants seem to be the worst for some reason that I’ve never understood. Perhaps it confuses the customer.

However, if you want to sell a business on you need to be able to demonstrate value. Now as a rule of thumb, you might expect to sell the business at 3 times its annual earnings. For instance when we bought the biological controls business from one of our suppliers they wanted £10,000 for it. After a bit of due diligence it turned out that it was earning about £3500 a year on the bottom line – so £10,000 was a fair price. Rich Dad[1] is always going on about creating income streams that you can buy and sell. This, for once, is an example of a real one.

Traditionally, we tend to think that the value of a company depends a lot on its fixed assets but in today’s markets that’s not true. It’s been calculated that the brand value, goodwill, or intangible value (call it what you will) represents about 85% of the value of a typical 21st century business. The intangible value for a listed company is the difference between the book value and the share price. If you want to show off you can refer to this ratio as Tobin’s Q.

However what results in the bottom line? Value resides in

  • What’s in people’s heads
  • How good your processes are and how happy your staff are
  • How many good customers you’ve got
  • How good you are at developing and communicating the right products – and how good you are at turning these into formal IPR
  • How tight your financial management is

So I would have thought it was a worthwhile exercise to construct a set of indicators that are easy to get at but which can track the growth of value in the business so you can convince potential buyers that the business has real intrinsic worth as an ongoing cash generator rather than having been lucky with a few years figures. In any case it will give you much better control over where you are going.

Successful companies build a formal systematic structure to achieve a defined set of income streams which are worth acquiring. They do this by maximising the value of the company. They tend to see it the way the diagram shows it.

buildingValue

What incoming purchasers or investors are interested in is whether there is a systematic means of generating profits which relate to

• A real customer need

• An unfair advantage

• A team that can deliver the results by remote control

But achieving this in a systematic way involves pulling a whole lot of different things together. It’s lucky for us that in the UK we have the data readily available to benchmark ourselves. In the UK, the Small Business Service commissioned a benchmarking study from the Cranfield Management Institute which established the scores across a wide range of indicators for the median, worst quartile and best quartile companies. The top quartile, in non stat-speak, means the score for the company 25% of the way down the ranking while worst quartile means the company 75% of the way down the list. So if you’re up there with the top 25% you’re probably doing ok,[2]

The thought leaders in measuring the growth of intangible assets in a business were probably Skandia who for some time published such measures in their balance sheet. They followed the principles of the balanced score-card which identifies

• An innovation focus

• A people focus

• A customer related focus

• A systems/process focus

• Which leads to a financial focus

So if we followed their lead what might we come up with? Well talk about that in the next post – we’ll  start with innovation.


[1] Of course I mean Robert Kiyosaki – author of Rich Dad Poor Dad

[2] Alas the DTI have withdrawn this paper but if you email me I’ll send you a copy

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