How Business Owners Can Maintain Profitability With Rising Labor Costs- Valutrics

At the start of 2017, the minimum wage increased in 19 states across the country, and two more states plus the District of Columbia are scheduled to see wage hikes later this year. Rising labor costs are a fact of life for many small businesses, and a financial reality that can affect business value.

As a small business owner and future seller, what do minimum wage increases mean for your company? Better yet, what can you do to maintain the value and profitability of your business when labor costs suddenly escalate?

Minimum Wage Increases and the Business-for-Sale Marketplace

Nearly half of U.S. states have either enacted or are scheduled to enact minimum wage increases this year. Although the push for a $15 per hour minimum wage has captured headlines, it’s important to note that none of these states come close to meeting that controversial threshold. In fact, California tops the list of the 21 states increasing minimum wage this year, raising the mandatory wage for non-exempt workers from $10 to $10.50 per hour.

But any wage increase inevitably creates new challenges for business owners. It’s not just about managing the impact of rising labor costs on cash flow and profitability. Owners also need to consider how higher wages affect business value, especially if they plan to exit their companies in the next few years.

In a BizBuySell.com survey of business brokers, respondents split on whether higher minimum wage rates affect companies in the business-for-sale marketplace: 47 percent believed that higher wages have no impact, while 51 percent argued that minimum wage increases negatively impact sellers. Only 8 percent of brokers reported having a client who sold their business due to actual or anticipated minimum wage increases.

In labor-intensive industries, minimum wage hikes strike a deeper blow than in industries with fewer hourly employees. But it’s safe to say that while higher labor costs probably aren’t a primary motivation for selling a business, owners and sellers need to proactively manage the financial impact of labor rates on their companies.

Adapting Your Business to Higher Labor Costs

Rising labor costs put a strain on small businesses, potentially impacting their profitability and valuations. Fortunately, owners and sellers can take several measures to manage financials and business value when labor costs increase.

Raise prices. Raising the price of goods or services is sometimes the best response to increased labor costs. Although any first-year economics student will tell you that a price hike can lead to lower demand, the effect on business value may be negligible, especially if the cost increase applies to the entire industry. Since most small businesses generally sell for standard multiples of revenues and cash flow, modeling the impact of any considered price change on revenues and profits is advised.
Explore other cost efficiencies. You can’t skirt hourly wage increases associated with legally enforceable minimum wage hikes. But you can offset wage increases with cost efficiencies in other areas of the business. By making your business more efficient, you can minimize the financial impact of higher labor expenses and make your company more attractive to potential buyers.
Reduce the number of employees. No small business owner wants to lay off employees. But if the business relies heavily on non-exempt workers, a significant bump in the minimum wage can leave owners with no choice but to reduce the number of employees on payroll. As a seller, downsizing can be an effective way to improve business value in the face of rising labor costs, as long as reduced staffing doesn’t jeopardize operations.
Decrease employee hours. An alternative to downsizing is to reduce employees’ hours. The upside is that the business can immediately recapture additional labor costs attributable to higher wages. But the risk is that fewer available hours could also increase turnover, and a high turnover rate will make the business less appealing to buyers.

Minimum wage is a complex issue and opinions vary about whether wage hikes are beneficial for small businesses. A 2016 Manta survey showed that most small business owners (59%) favor a higher minimum wage and 40 percent already pay entry-level employees “far above” the legally required threshold based on the belief that well-compensated employees are good for the business.

But regardless of where you fall in the debate about minimum wage, it’s important to know the effect that rising labor costs will have on your business. Develop a strategy to minimize the impact of rising wages on the value of your company now, before you find yourself struggling to navigate the impact of a sudden wage hike.