Too many companies grow their revenue without knowing if they're actually earning a reasonable margin. Most literature will tell you that a growing top line is critical to a higher valuation. However, if you are growing your revenue line by offering your services at a discounted price, are you really creating value? In my previous article, "Intrinsic Value per Share and the Roadmap to Measurable Value Creation," I singled out clean revenue as one of seven drivers of a higher multiple. In this article, I get into this concept in a bit more detail.
Revenue can be improved by increasing price, improving utilization or productivity, and/or increasing volume. However, companies get in trouble when they start increasing volume by discounting their prices or taking on subprime clients to secure market share. This is a slippery slope.
When buyers look at businesses, they assess the quality in the numbers more than the quantity in them. A company that generates $10 million of EBITDA on $50 million of revenue (a 20% EBITDA margin) is more valuable than one that does the same $10 million of EBITDA, but on $80 million of revenue (a 12.5% EBITDA margin). The more profitable company often has a much lower working capital investment, lower equipment requirements, and lower labor intensity than the lower profitable one. Both deliver the same EBITDA, but the more profitable one does it with less effort.
Therefore, it is not just about being the biggest and chasing any revenue. It is about chasing "good" revenue and walking away from revenue that does not meet your company’s margin threshold. In fact, even before chasing new work, good companies audit their revenue lines first to determine how valuable this revenue is. Here’s how they do it:
They Understand Their Value PropositionWhy do clients pick one company's product or service over its competitors? Why would they pay a premium? Good, valuable companies know this answer cold. They know their value proposition. Therefore, the first thing to ask yourself is whether your company offers a commodity or not. If it doesn't, then what differentiates your product of the following:
- Is it the service around it?
- Is it the warranty?
- Is it the fact that it is supplied, installed and delivered always on time, on budget and safely?