In the current economic landscape, banks are facing various challenges such as debt ceilings, inflation concerns and interest rate issues. As a result, they have become more cautious about selecting attractive loan candidates among small and medium-sized businesses. Merely showcasing consistent financial performance and a strong growth story is no longer sufficient.
With the realization that banks now demand a more thorough and intricate assessment, accountants need to underscore the significance of nonfinancial metrics and environmental, social and governance indicators. Given that business owners must take these factors into account to strategically position their enterprises and maneuver through unpredictable market circumstances, possessing a deep understanding of advising businesses on non-financial aspects becomes paramount in this economic climate.
Broadening the evaluation scope
Historically, financial performance analysis, including factors such as historical financial statements, cash flow projections and budget forecasts, have sufficed. However, this is no longer adequate in the evolving banking landscape. Non-financial metrics have gained prominence, and lenders and potential acquirers now place equal importance on both financial and nonfinancial indicators.
Drawing on years of experience in succession and exit planning, we have observed that over 150 nonfinancial metrics across various areas significantly influence lenders' decisions and overall business valuations. These metrics encompass corporate governance, occupational health and safety, IT and cybersecurity, environmental sustainability, remuneration models, and management structures.
The value of nonfinancial metrics
Nonfinancial metrics allow accountants to present business owners with a strategic approach to reduce risk, enhance value, and improve their chances of securing successful loans. These metrics impact the potential valuation multiple a business can achieve upon sale, making them crucial considerations for lenders. Accountants can add instant value by focusing on the nonfinancials that business owners have significant control over, allowing for relatively easy improvements.
Five key areas of nonfinancial evaluation
1. Risk analysis: An extensive risk analysis should encompass six key areas: people (management, remuneration and incentives); IT and cybersecurity, corporate governance (management and controls, advisory board and reporting processes); health and safety, compliance and regulation (taxation and financial obligations, legal and licensing); and financial management (reporting, controls, cash flow management, budgeting and forecasting). For instance, businesses heavily reliant on founders and key personnel face increased risk should they depart. Implementing a clear remuneration strategy or an employee share plan can mitigate the potential consequences of staff turnover, supplementing good HR practices.
2. Environmental, social and governance: ESG factors have a tangible impact on a company's financial performance. Research from Harvard Business School indicates that companies with strong ESG performance tend to have lower capital costs and higher valuation multiples. ESG factors influence financial performance through reputation risk, operational efficiency and innovation. Businesses with robust ESG performance are better positioned to attract and retain customers, employees and investors.
3. Succession planning: Having a well-defined succession plan is essential, including identifying who will lead the business when the owner retires, resigns or passes away. Additionally, it involves planning for long-term ownership succession and exit strategies. Implementing a board structure and buy/sell agreements can mitigate governance risks and potential issues arising from partner departures or unforeseen circumstances.
4. Benchmarking and profit gap analysis: Benchmarking against industry peers enables businesses to identify areas for improvement and prioritize growth opportunities. By examining peers in fundamental areas such as business model, financial management, human resources, compliance and management teams, businesses can gain valuable insights and enhance their competitive advantage.
5. Value acceleration: Illustrating the risks inherent in a business helps prioritize actions and develop a robust growth plan for the equity value of the enterprise. Identifying potential risks and taking proactive measures
These nonfinancial metrics provide a holistic view of a business's operations, governance and sustainability, aligning with the evolving priorities of lenders and potential acquirers. In today's complex economic landscape, small and medium-sized businesses seeking loans must go beyond traditional financial metrics to enhance their candidacy.
By focusing on areas such as risk analysis, ESG factors, succession planning, benchmarking and value acceleration, accountants will help business owners mitigate risks, increase their company's value and improve their chances of securing loans successfully. Embracing these metrics not only strengthens a business's position in the market but also enables them to navigate uncertainties and seize growth opportunities. As the banking landscape continues to evolve, understanding and incorporating non-financial metrics into the broader discussion by accountants with business clients will be crucial in ensuring long-term success.
