What shape is your revenue?

When I ask a business leader

“What was your revenue last year?”

I’ll get a number as the answer. That tells me a little about the business, but from a business value perspective I want to know a lot more.

The next question is

“How many active customers do you have?”

This often leads to a debate about the definition of an active customer, but usually gets an answer fairly quickly. I think an active customer bought from you within the last 12 months.

There are two more elements that go to make up the revenue profile, how often does your customer buy (f) and what is the average order value (AOV)

The formula looks like this

rev shape

Where T is your turnover and n is your number of customers.

From the business buyers perspective, once n has reached a minimum level what matters next is the frequency with which the customer buys.

It is important not to become too reliant upon one customer and prospective acquirers will be worried if one customer exceeds more than 20% of your revenues.

A customer who buys from you once a year is typically worth less to an acquirer than one who buys 3 or 4 times a year.

There are exceptions. It might be that the once a year purchase is from a “Marquee” customer; someone you are proud to do business with and usually someone who commands instant name recognition.  If you are able to state “We supply John Lewis” that will count as a marquee customer, but other examples might be government business or the NHS.

The most valuable customers are those who are on long term contracts, where you are providing goods or more likely services.  These are very common as support services, for example in IT or building maintenance.

Within these contracts there are a few things to look out for to ensure you maximise the value.

A real “Red flag” for the buyer is if the contract contains a “change of control” clause, allowing your customer to break the contract if the ownership of your business changes.

It’s good to have contracts set up as “evergreen” where the contract automatically renews unless one party (or the other) gives notice, but within these there will need to be some form of pricing mechanism.  You don’t want to be trapped in a contract where your costs have dramatically increased, but you are unable to adjust your sale price.

If your business doesn’t lend itself to long term contracts, aim to move as far down that road as you can. Become an approved supplier or a preferred supplier or enter into some form of framework agreement – anything you can do to evidence a strong relationship with your customer.

If you want the best value for your business, you need to show that your revenues (and your profits) are growing, year on year.

That does not necessarily mean that you should keep adding new customers. If you can increase the frequency with which your customers buy, your revenues will grow. If you can increase the average order value, your revenues will grow.

 

 

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