A Penny Saved or a Penny Earned – How Would You vote?
With five bad years behind us and a double-dip recession still a possibility, virtually every business we’ve encountered would count getting back to 2007 sales levels as a moral victory. Customers are hanging on to their money and incremental sales growth may be slow for next year. Throw in some uncertainty about where personal and corporate tax rates will be 12 to 24 months from now, and you see an environment where business owners and managers are wondering where profits are going to come from over the next few years.
If additional sales and higher margins are looking unlikely, perhaps your company is better off focusing on cutting costs. With apologies to Ben Franklin, a penny saved can be worth a lot more than a penny earned. What Mr. Franklin failed to take into account was the discount rate – the time value of money and the risk factors associated with the income stream – that companies apply to their investments. For those in the audience without MBAs or CPAs, the time value of money relates to the interest rate one sets as acceptable for a safe investment and the risk factor relates to the degree of certainty that one feels about the expected income being realized.
While different businesses and industries have varying discount rate expectations, a rate of15% is a common target. Using that 15% as an example, along with the simplest (and lowest) net present value calculation, cutting expenses by $100,000 adds over $477,000 in value to the company over a span of 10 years. A penny saved, you see, is worth 4.7 pennies earned.
For a client whose industry focuses on EBITDA for appraisals, reducing costs has a similar value. If the valuation multiple in an industry is between five and seven times EBITDA, that $100,000 in savings makes your business worth another $500,000 to $700,000 in sale price. Add that to any sales increases during the same period, and a company has gained extraordinary leverage toward increasing its market value.
It’s true that you can never achieve success simply by cutting costs; building sales is the key to growing your business. But an effective cost-cutting effort can have a powerful additive effect on profitability and business valuation. If we can help you get more profitable by getting to the best possible costs on operating expenses, let us hear from you.
These calculations also have a material effect on your company if you are thinking about selling your business in the next few years. A frequent business valuation tool in many industries is “multiple of EBITDA.” That’s an acronym for Earnings Before Income Taxes, Depreciation and Amortization – a quick measure of a company’s operating cash flow. If the multiple in your industry is between five and seven time EBITDA, that $100,000 in savings makes your business worth another $500,000 to $700,000 in sale price. Add that to any sales increases you can realize, and you can gain some extraordinary leverage toward increasing the sale price of your business.
It’s a rare business that isn’t looking for ways to save money in times like these, but in many cases management hasn’t quantified what the value of saving money on operating expenses can do for the value of the company. While it is true that that no business ever saved its way to prosperity, cutting expenses in areas that do not affect product quality or customer service and reinvesting those savings in areas that build sales revenue is a recipe for success. I think that even old Ben would agree with that.