This video briefly discusses the importance of margin in our businesses and our lives. Everything we do is at the margin of time between the past and the future. Put enough focused days together and, at the margin, we can positively impact our personal and business lives.
Margin. Everything that happens in your life or your business or my life or my business happens at the margin.
This is Chris Mercer with a Valuation Video — call it “Margin in Business and Life.”
I learned about margin the hard way, I guess that’s like everybody else. But everything happens at the margin. The margin between the past — that is, it’s already done, we can’t change what we’ve done in the past — and the future, or tomorrow. We can’t anticipate, we can’t do anything tomorrow. We can only act today; we act at the margin of life.
Early on in life, I’m grateful that I learned a very basic principle — and that principle is to spend less than you make. It’s been said that the difference between happiness and great distress in life is spending the proverbial dollar less than you make —where you can accumulate something for rainy days and for retirement and things like that —or a dollar more than you make — where you’re in distress all the time. Personal financial margin is important.
I began to learn about business margin in Principles of Economics. I learned in Economics 201 that a firm maximizes its profits by expanding output and charging a price commensurate with its marginal cost equal to its marginal revenue. That was an important concept before I knew anything about business. When I got involved in business, I learned that margin is important. There are a number of business margins: the gross margin — operating income less the cost of goods sold, the operating margin — less cost of goods sold less operating expenses, the EBITDA margin — add back depreciation and amortization — like the EBITDA we’ve been talking about in previous posts, and the net margin. Now, this margin concept in valuation is really important because you take an appropriate multiple for a particular valuation indication right here. The multiple times the margin is equal to price to sales. So the key to increasing the value of your business relative to its sales is to increase margin. That is a critical concept.
A number of years ago, I wrote a booklet called “Is Your Business Ready for Sale?” In that booklet, I introduced a subject that I called “Margin Magic.” A simple illustration: a company has revenues of $10 million, expenses of $9 million, and income of a million. So it has a 10% margin in the last most recent period. Now we’re at day one of the next period and we’re going to act today and tomorrow and the next day for the coming year. And we’re going to act in such a way that we increase revenue 5%, not a big increase, to $10.5 million in revenue. We increase expenses only 4%. That differential has important consequences because expenses went up to $9.36 million and income went up to $1.14 million or 14%. Importantly, the margin went up to 10.9% and the margin times that multiple of 8 that we mention, $8.72. $8.00 price per sales in the first case, $8.72 later.
So, if you’re thinking about your business and whether is it ready for sale, one of the things you might want to do is be sure that you’re taking care of any low-hanging fruit by increasing revenue relative to expenses while you’re in control so that someone else doesn’t get that low hanging fruit and that bump in value that’s probably available in your business — it certainly is available in many businesses. So do that now, but think about the margin in your business and think about “Margin Magic.”
Chris Mercer here, I enjoyed talking about margin in business and life. If you’d like to talk to me about margin or about anything that’s valuation-related, you can call me. The phone number is readily available on the website (901-685-2120) and you can respond with questions on LinkedIn or on ChrisMercer.net.
Until the next Valuation Video, good day.