MANY agency owners wonder why growth should be a factor in an agency's valuation. Most understand why profit margin is a key component, but they sometimes question the importance of growth. The reason lies in what the buyer is actually purchasing.
Excluding speculation, every business value is based on free cash flow, which, barring financing activities, comes from profit. In valuing a business the buyer must consider future, rather than present, cash flow.
Since we are concerned with future cash flow, growth must be considered as well as profit margin. Growth generates profit just as much as good expense control does. Growth multiplies the profit margin. For example, if an investment's profit margin is 15% and growth is 5%, then over five years the investment will generate profit equal to 83% of the first year's revenue. If growth is 10%, profit will equal 92% of the first year's revenue. Therefore, a company with a higher expected future growth rate than another (and with the same profit margin) is the more valuable.
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