Which is More Valuable, Large Profit Margins or Large Revenue?
It is not a mistake to always be thinking of the day you implement your exit strategy and sell your business as you are in the process of growing it. Many years before you go to sell your business, you are making decisions on new product lines, strategies, or new customers. There are many factors you consider to make such decisions including risk, capacity, opportunity costs, etc. One question you might ask yourself is the effect that decision will have on the value of your business some time in the future. How will a Business Broker or M&A Intermediary value your Business for Sale?
A critical trade off with many product lines, customers, or strategies is the age old revenue vs. margin argument. Is it better to start a product line that will increase revenue, but have a detrimental effect on your profit margin? Is it better to take on a large customer, even though they demand a steep discount on your products?
When it comes to the value of your company, the answer is clear. Revenue wins. The positive effect that higher gross sales will have on the value of your business to a buyer is proportionally higher than the the detrimental effect on the value of your business which will come from a lower margin percentage. In other words, a buyer will value a bigger revenue number more than a larger profit margin.
This is backed up by a report from Pratt’s Stats. In it they broke down completed business sales submitted by business brokers by three revenue categories. The categories were businesses for sale with revenue <$1 million, $1 million to $5 million, and >$5 million. The multiple of Selling Price to EBITDA went from 3.81 (<$1 million category) to 6.99 (>$5 million category), and the multiple of selling price to revenue went from .50 to .55. Yet the profit margins of these firms went from 12% to 5%.
For example, if your company has annual revenue of $2.5 million, and you have the average net profit of companies in that range of 8%, your company is worth on average $960,000. Let’s say you have a product that will help you maintain your profit margin, and increase revenue by $1 million. Your company is now worth $1,344,000. But, let’s say you went with a product that netted only 4% margins, but had an additional $2.5 million in revenue, making your businesses average margin 6%. Your business would be worth $2,097,000! That is a significant difference.
The moral of the story is, go with revenue over margin to get a better value for your business.
