22 Oct Reduce Risk to Increase Your Economic Value
In my previous blog I wrote about managing your costs to increase profitability and the value of your IT business. Let’s change gears and talk about something else that is related to value, but is more difficult to measure than sales and profits. I’m talking about risk. Risk refers to stability of earnings and diversity of customers, products, services and markets. Investors in the stock market fully understand that companies with lower risk factors are generally worth more. But how does this apply to a privately-held IT company?
It’s difficult for any company (especially a small, private business) to link individual risks to their associated economic value. Here we don’t need a methodology for measuring and minimizing risk–we need a philosophy that allows owners and executives to make better decisions and optimize their business to achieve its greatest value.
One way to reduce risk is to consistently focus your company’s energy on profitable activities. I’ve already discussed growing top-line and bottom-line numbers. Now let’s take a look under the hood at your individual lines of business (LOBs). If you can measure them, then you can invest in the LOBs that are doing well and eliminate (or sell off) those that are under-performing. If you can’t properly compute the results of your LOBs, then consider changing your accounting system to one that can. You can use the same thought process when considering new projects for the company and evaluating the need for a system that can best measure project profitability.
Another way to reduce risk is by increasing your economic value through intelligent use of debt and credit. The way that you finance your business growth (such as customer pre-payments, borrowing, or selling equity) and the resulting cost of capital can have a huge effect on your economic value. It’s also important for business owners to understand their working capital, commonly defined as current assets minus current liabilities. This number represents the liquidity of your company. Think about your business from the perspective of an outside buyer, who would examine your balance sheet to ensure that the organization is sufficiently capitalized and not in any financial trouble.
If you can reduce the risks (from a buyer’s perspective), then you have increased your company’s economic value and made the business more attractive. In my next post I’ll describe more ways to reduce your organizational risk and increase the value of your business.