A Key Driver in the Evaluation of a Business

HOUSTON, TX / ACCESSWIRE / March 3, 2023 / Conadat Gomezis a trusted advisor and business partner based in Houston, Texas. Known for having a forward-thinking focus as well as technical finance and accounting expertise, Gomez has decades of experience in the field. Here, he discusses the all-important process of business valuation and its key driver: revenue growth.

Conadat Gomez explains that business valuation is used to determine the economic value of a business. He notes that various techniques are used in order to determine this value, but most seasoned finance executives use an income-based valuation model which is mainly driven by revenue growth- also the key driver of EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization).

There are numerous reasons as to why a business might need business valuation. Two of the most prevalent include 1.) Selling or buying a business, and 2.) For lending and/or banking purposes.

Gomez stresses that revenue projections and growth should be vetted thoroughly in the valuation process. This is done by analyzing revenue by business segment as well as key products or services. For example, when assessing a potential acquisition, revenue growth gained year over year should be reasonable. If a company is projecting double-digit revenue growth in their valuation model, this could be a red flag because such consistent revenue growth may not be sustainable.

Conadat Gomez also shares several key factors that should be analyzed as part of the valuation process:

• Business revenue segments and margin by key major segments or revenue streams and by key products or services. While a key product or service may still be in the growth stage, it cannot be assumed that other key products will have an equivalent growth rate. This is a common mistake made when looking at revenue growth. In fact, a key product or service with historically high margins may be in the mature stage and may actually decline in sales in the future. If incorrectly projected, revenue growth and margin for the business may be overstated.
• Seasonality: Time of year may affect business revenue. An example would be a lawn care business which would have higher revenue during the late spring and summer months as opposed to winter and fall. Keep in mind that seasonality will impact business growth and EBITDA projections.
• Fixed overhead expenses: Aside from sales people, a company’s double-digit revenue projections may require additional purchasing or warehouse employees. These non-revenue generating positions are needed to help sustain growth, but additional payroll expenses need to be factored into projections. More importantly, the additional payroll expenses should include the fully burdened expense in addition to the base salary. This would include bonuses, the employer portion of social security and medicare, healthcare, as well as other employee benefits.
• Recurring revenue opportunities, on the other hand, can positively influence the valuation of a business. For example, a computer repair business with an established customer base may offer a subscription revenue model vs. a one-time transactional model which could increase revenue. There more recurring revenue contracts a business has, the higher its valuation will be.
• Capex spend (capital expenditure) is money invested by a company to acquire or upgrade fixed, physical, or non-consumable assets. Primarily a one-time investment to foster future growth, capex can have a significant impact in the projected free cash flow of a business. Some industries may require additional plant, property, or equipment to support growth, but if two companies have identical revenue growth year over year of 15%, the company requiring less capex to sustain its revenue will have higher valuation.

Conadat Gomez notes that revenue business growth projections may vary significantly based on the company’s sales model or business cycle. He warns that those interested in business acquisitions should watch out for double-digit revenue growth using the above factors. For further information contact Mr. Conadat Gomez at [email protected]

SOURCE: Sternberg Law Firm