Knowing the difference between growing revenue and growing equity value is another step to add value to your business. Business owners buy or start a business to grow top-line revenue and subsequent profits. As I talk to business owners that’s their number one goal. Growth by itself is a goal, but without direction or a strategy behind it, it is just a catchphrase.
So what is the difference between growing revenue versus growing equity value? To begin with, growing revenue is usually measured in months or year to year. Growing equity value is usually a longer-term strategy. Typically, when we engage a new client, we want to understand what their short and long-term goals are. When we have an understanding of their current situation and their future desires, we typically perform a business valuation. The business valuation is used to benchmark the current value of the company. Most of the time the value falls short of where the owner feels the value needs to be to successfully exit the company.
Growing revenue is usually required to reach the longer-term goal of increasing equity value. However, growing revenue without considering the impact of the future value may be short-sighted.
Case in point: Company A’s short-term goal is to grow topline revenue by 10% this year. To accomplish this goal, they cut their prices. Revenue goes up, but profits go down. Inventory increases, accounts receivable increases, bad debt also increases. Revenues go up, and equity value goes down.
Revenue growth by itself does not take into consideration potential waste associated with rapid growth and other risk factors. Building equity value over the long-term does include mitigating risk associated with growth. As an example, the CEO of a manufacturing company wants to retire in five years. His production manager wants him to purchase a new CNC machine for $200,000. The new machine will reduce costs but will take ten years to pay for itself. The CEO finds a used machine for half the price, and the payback is five years. Since the CEO is planning to exit, he chooses the less expensive option.
As business owners begin to focus on equity value, they apply the same lens on all decisions and ask the same question will this decision or investment increase or decrease the long-term equity value of my company?