In fast paced industries such as IT, Biotechnology etc. companies can be broadly classified into two primary groups: Build to sell (BTS) and Build to Grow (BTG). BTS companies are driven by the dictum “build fast” and “maximize valuation”. BTG companies are more focused on “Profitable, multi-year sustainability”. With these fundamental guiding principles defining their behavior the finance function within the organization must pursue appropriate shades of levers to reach the end goals. For both BTG and BTS companies the financial value drivers are: Profitability (P), Costs (C ), Capital Structure (CS), Investment (I), Capacity(CP) and Intangibles (includes goodwill and Patents and trademarks).
Profitability: Profitability is the primary goal of all business ventures. Companies built to sell must focus on profit maximization, expansion of customer base and specializing in the existing product and in a wide market. The profit to sales ratio when compared to historical results and industry averages need to favourable signifying efficient management of revenue and costs. For, BTG companies the focus should be more than make profits. The major consideration should be increase in the market share, investment in R & D and best quality resources thereby enhancing the quality of the product and constant innovation in products to become a reliable and long term player in the market. Companies can use the surplus cash for growth strategies, such as investing in research and development, expanding capacity and exploring new geographic markets. The focus is therefore on creating long term growth and sustainability for the organisation.
Cost: Cost containment strategies are widely adopted to ensure organisations meet their financial targets. BTS companies must incur expenditures that have an immediate impact on the revenues and financial performance of the company. The reduction in operating cost of a company is a good indicator to the buyer on the efficient utilization of resources and management of activities. BTG companies would incur expenditures on items creating an impact over a period of time like bringing in good quality resources, research and development and expenditures required for future growth. The financial and operational aspects of growth must be balanced during expansion of business. Cost control would be on items which do not have a lasting impact and does not match the intended outcome.
Capital structure: A company’s proportion of short term and long term debts are considered when evaluating the capital structure of a company. The debt equity ratio is an indicator of the company’s internal and external liabilities. It reflects the financial position of the company as it is a measure of the financial leverage. BTS companies should thrive to showcase good profit margins to attract buyers and maintain less long term obligations and improved liquidity positions. BTG need to make strategic decisions in maintaining favourable debt equity to ensure long term sustainability.
Asset Investments: BTS firms must focus to invest on creating a value for the company and a predictable future. Any investments on assets that are yielding substantial short term returns is favourable and to signal liquidity maintain favourable current asset ratios.
BTG invest in assets based on the expectation that this investment, which is intended to last a long time, will result in continuous positive income. These organizations concentrate more on the Asset Turnover Ratio. This reflects the management philosophy of owning the resources and being less vulnerable to increase in costs and volatility in the market in the long term.
Goodwill: A business acquires goodwill through best practises, customer service, innovation and good governance. BTS strive in creating a value for the company which is associated with loyal customers, brand, continuous innovation and trust in the market. More emphasis is on creating a Unique Selling Proposition (USP) which would provide a competitive advantage and define the business. When the company is sold, the buyer pays a notable amount on the goodwill earned by the company. BTG not only focus on offering best customer experience, but also on the quality of the products, long term relationships with customers and pricing fairness. The companies build goodwill over a period of time and penetrate gradually to establish a strong foothold in the market.
Patents and Trademarks: Corporate valuation relies greatly on a company’s intellectual assets such as patents. Business enterprises perceive patent portfolios as a demonstration of high level of expertise and specialization within the company. Patents also provide licensing opportunities. BTS focus on creating patents for their organizations as it increases the overall corporate value. BTG focus on constant innovation and believe in consistently improving the product/services. Patents are a part of the growth agenda, but the prime focus is on defending the products and markets from poaching, and creating a competitive advantage for the company. BTG companies create patents to exclude the competitors from exploiting the right to make/sell, more from a technology protection perspective than enhancing the value of the firm. They end up investing in related patents and standards to cover their technological grounds.
Capacity Utilization: A firm’s productive capacity is the total output it can produce within a given time period. BTS the focus would be showcasing themselves as a company utilizing near 100% capacity. This would indicate the buyers that the organization has enough work on hand and the cost per unit is also minimised wherein there is optimum utilization of resources. The firm is assumed to be using all of its fixed assets effectively; therefore the profits should be high. Two approaches that could increase capacity utilization could be by reducing the factors of production employed or move into smaller premises/ cut down investment on facilities. For BTG, the focus is to efficiently utilise the resources and capacity expansion to facilitate future demands and cope up with new orders. Firms in expanding markets may expect to have low utilisation while they build their sales and establish themselves in the market.
Finally, as novelist Nora Roberts says…”Know what you want, and work to get it!!!”
-Pratibha Sharma