Key Drivers of Value - Part 2

The Benefit Stream

In a previous article, The Value Trifecta, we discussed a three-part equation concerning the intricate interrelations between profitability, risk, and growth and why this equation is important to business owners and managers. 

So what is the benefit stream exactly?  The answer is not as simple as it implies.  It is not any strict definition of income nor must it strictly adhere to historical performance.  The benefit stream can represent various forms of economic benefits that are able to be capitalized into value.  The Business Valuation Standards of the American Society of Appraisers describes the benefit stream, or "anticipated benefits," accordingly:

Anticipated benefits are expressed in monetary terms.  Anticipated benefits may be reasonably represented by such items as dividends or various forms of earnings flow? Anticipated benefits should be estimated considering such items as the nature, capital structure, and historical performance of the related business entity, the expected future outlook for the business entity, relevant industries, and relevant economic factors.

Notice the use of the term "anticipated benefits."  Why was this term selected?  The answer relates to the previous comment regarding the nature of the benefit stream.  Simply using strict historical net income, EBITDA, or net cash flow as the benefit stream runs the chance that you might not be correctly taking into account your operations as an investor would.  More often than not, evaluating risk (which is accounted for in the discount rate) is a key part of determining what level of benefits appropriately describes your business going forward. Though a three-part equation, the determination of its individual factors stems from the same systemic, macro analysis of the various factors that can affect a business. 

It is imperative that managers and owners know that this selection is, in fact, a fairly subjective analysis unique to each business or security.  Simply put, you might not being doing your company justice by simply selecting net income for the most recent fiscal year (you might also be overstating the same).  Sit down and take a look at a period that you believe is representative of a full business cycle of your business.  How has your business done during this period?  Any one-time large contracts? Any significant one-time expenses?  More importantly, look at the future.  Ask, "What is coming my way?"  Often, managers have many different tools, such as SWOT analyses and forecasting, that assist them in identifying possible trends and events which could influence the performance of their business.  More importantly, investors looking to buy your business are doing the exact same thing. 

The benefit stream should conceptually be a value representative of what one could expect to receive year in and year out into perpetuity.  The purpose of this process is to normalize the benefit stream through the elimination of operational anomalies.  Oftentimes, it is a selected number not directly tied to historical performance.  The key takeaway: managers, sit down and take a look at your margins, contracts, marketing plans, and whatever else you believe influences performance.  Analyze the trends and make a decision as to what level of earnings the business can generate on a consistent basis.  Is history a reliable predictor of future events?  Examine by back-checking actual results to previously prepared forecasts.  Is your business growing fast or in a changing market environment?  Look at the opportunities and other events that lie ahead.  Managers must understand that the value of the business is not necessarily stated in terms of a strict number or definition of earnings.  Those results are nominal, and though they might very well be representative, they might also be skewing actual operational performance.  If it turns out that this year's net income does in fact represent a stable, representative level of benefits that can be reasonably expected to be received in the future, so be it.  However, it is more often the exception rather than the rule.  The key to determining the appropriate level of benefits is to be confident in the metric you select as being representative of the continued operational success of your business. 

It is also important to evaluate this key driver of value and align it with strategic goals.  Managers and business owners should ask, "What can we do to increase the value of my business in terms of the anticipated benefit?"  What drives profitability?  Identify strategic initiatives and strategies and integrate them into operations.  Use past selected benefit streams as benchmarks for current selections.  As with all three key drivers of value, the benefit stream can be an important tool in understanding how to enhance the value of your business. 

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