In today’s fast-paced business landscape, the path to entrepreneurship often begins with rapid growth through online platforms. Some entrepreneurs build multi-million dollar businesses without a deep understanding of financial fundamentals, but when it comes time to exit, they must confront the essential financial metrics. Whether you’re buying or selling a business, these key performance indicators (KPIs) can make or break the deal. In this blog post, we’ll explore nine vital KPIs for business acquisition and why they matter.
The Primacy of Financial Metrics
First and foremost, it’s crucial to understand that financial metrics should take precedence over marketing metrics when evaluating a business for acquisition. While marketing metrics are important for gauging performance and strategy, they should always align with financial outcomes. A business’s income statement and balance sheet are the cornerstones of evaluation, as they provide a comprehensive financial overview. They act as a universal language in the world of business deals, understood by lenders, investors, and buyers across different industries.
Profit Over Revenue
One common mistake many business owners, especially those new to the acquisition game, make is overemphasizing revenue over profit. While revenue is a key indicator of growth and market presence, profit is the primary driver of business value. A business’s profitability tells a potential buyer how much money the business is truly making after accounting for costs and expenses.
The Value of Profit
Profit should be viewed as a primary driver of a business’s worth. When considering selling a business, it’s essential to think about how profit contributes to its overall value. Buyers often seek businesses with established profit margins, as these indicate stable and lucrative operations. Smaller businesses with lower profit figures may still have value but need to be priced accordingly based on their scalability and potential.
Understanding Earnings Metrics
When evaluating a business’s financial performance, you’ll need to understand different earnings metrics:
- Operating Profit: This metric calculates profit by subtracting direct costs and overheads from income. It excludes interest and taxes.
- EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization): EBITDA removes non-cash expenses like depreciation and amortization. It provides a more accurate picture of a business’s operational earnings.
- SDE (Seller Discretionary Earnings): SDE considers the real cost of running the business, which often includes the owner’s under-market salary. This is a crucial metric for evaluating small businesses, especially those with owner-operators heavily involved.
The Nuances of Valuation
Valuing a business is a complex task that depends on several factors, including the specific role of the owner and the potential need for additional staff or investments by the buyer. When determining the value of a business, consider what’s leaving when the owner exits. If the owner played multiple roles within the business, such as CFO, CMO, and CTO, their departure may imply a need to hire new staff, increasing expenses. Additionally, if the business is too reliant on the owner’s involvement, it may be perceived as more of a job than an independent business, impacting its valuation.
Different Buyer Pools
Just like in real estate, businesses have distinct buyer pools. Some buyers are interested in acquiring a business to run it themselves, while others want a business that can operate independently. These two types of buyers may assign different values to the same business. A business that can run without an owner-operator is often more attractive to a broader pool of buyers, potentially driving up its valuation.
Financial KPIs drive business value!
When it comes to buying or selling a business, the financial metrics take precedence, with profit being the key driver of a business’s value. It’s essential to understand different earnings metrics like operating profit, EBITDA, and SDE to assess a business accurately. Keep in mind the nuances of valuation, such as the owner’s role within the business and the potential need for additional staff or investments. By carefully evaluating these KPIs, you can make informed decisions that lead to successful business acquisitions. Remember, understanding the financial health of a business is critical to ensure you’re not about to “buy a turkey.”