I am sitting at Logan Airport in Boston suffering yet another flight delay (the subject of an entirely different blog) and thinking about lunch. A sandwich and coke at the local Hudson News is about $15.00 in total. But next door is a nice restaurant with table service. Entrée and glass of wine - $40.00 with the tip.
A month ago I would have opted for the $40.00 meal. That’s before a colleague of mine told me how he changed his thinking about operating lean. He explained that if you spend $40.00 on a lunch that has no real economic benefit to your company then you should actually multiply that expense by the earnings multiple you hope to get when you sell your company.
Let me clarify.
When a company’s market value is being determined one of the ways to arrive at a selling price is to multiply the average adjusted EBITDA of the company by a factor. The factor or multiple is usually based on the industry and risk associated with the company and the likelihood that the discounted present value of future earnings will be achieved. What is really important to know is that this factor can be anywhere from 5X to 10X in most companies.
So if the average EBITDA of a company in a low risk industry was $1,500,000 and the multiple was determined to be 8X then the value of the company would be $12M on the sale (8 X $1.5M).
Now back to the that meal that was going to cost me $40. Since I could just as easily spend $15 on lunch the $25 difference is generating no real additional economic benefit to my company’s bottom line. When it comes time to sell my business the $25 is going to become $200 ($25 X Multiple of 8). Wow… I doubt the food at the airport was worth that much! Imaging doing that once a week for an entire year – that’s $10k!
Now think about this in other non-production costs and overheads.
Let’s assume you don’t shop your annual building and liability insurance and you end up paying an additional $15k per year. Really you are paying $120k. That extra $5k salary bump you gave the underperforming person is going to cost you $40k on the sale of your company. The trade association that you are a member of that hasn’t generated a single dollar of revenue for you but makes you feel good … you get the picture.
I am not advocating that money spent on producing revenue isn’t worthwhile. However, I doubt many entrepreneurs would spend $1,000 to earn $500. But that is really what you might be doing if you are not always thinking lean and looking closely at the economic benefits of every dollar you are spending.
So the sandwich and coke wasn’t as nice as the entrée but when I add up all the savings from my new lean thinking I could walk away with a cool extra $500,000 in cash when the business was sold.
Remember cash is the oxygen of your business and every dollar you save is worth maybe 8 times the amount!
For additional help on operating lean and better managing cash flows contact us at Aventure Management.
Have a Happy and Prosperous 2017!
 EBITDA = Earnings Before Interest Taxes Depreciation and Amortization. Calculated by taking the pre-tax income of the company and adding back interest expense from all debt and leases and depreciation and amortization charges for the period.