{"id":561107,"date":"2012-06-27T07:23:53","date_gmt":"2012-06-27T11:23:53","guid":{"rendered":"https:\/\/vrbbd.wpengine.com\/vrbbgreenbay\/simplifying-valuation\/"},"modified":"2022-01-31T12:44:13","modified_gmt":"2022-01-31T17:44:13","slug":"simplifying-valuation","status":"publish","type":"post","link":"https:\/\/www.vrbusinessbrokers.com\/vrbbgreenbay\/simplifying-valuation\/","title":{"rendered":"Simplifying the Valuation"},"content":{"rendered":"
\n

\u201cThere are many reasons for valuing an entity, and those circumstances can lead to different outcomes\u2026For instance, a business\u2019s value for sale on a going-concern basis will differ from its value for liquidation purposes.\u00a0 It similarly makes a difference if the valuation is for an orderly liquidation as opposed to a forced one.\u00a0 For example, the value of a company for estate-tax purposes (fair market value) likely will differ from its value for a sale to a specific purchaser (investment or strategic value).\u00a0 In some instances involving litigation, the courts or the law may dictate which standard of value to use.\u201d<\/p>\n

\u00a0\u00a0\u00a0\u00a0\u00a0Source: Journal of Accountancy , August 2003<\/em><\/p>\n

Introduction<\/strong><\/b><\/p>\n

The two variables \u2013 EBIT and DCF numbers \u2013 are affected by not only the financial aspects of the business but also the non-financial aspects, which can be both objective and subjective.\u00a0 For purposes of buying or selling a company, it is important for the seller to determine the floor price (the lowest acceptable price) and for the buyer to determine the walk-away price (the highest possible offer).\u00a0 Valuing companies may be more of an art than a science, but there are three basic factors that buyers focus on when trying to establish a price for a target company.<\/p>\n

1.\u00a0 Q<\/strong>uality of Eearnings<\/strong><\/b><\/p>\n

i.e., not a lot of \u201cadd-backs\u201d or one-time events like the sale of real estate which does not reflect on the true earning power of the company\u2019s operations.\u00a0 It is not unusual for companies to have some non-recurring expenses every year, whether it is a new roof on the plant, a hefty lawsuit, write-down of inventory, etc.<\/p>\n

2.\u00a0 S<\/strong>ustainability of Earnings After the Acquisition.\u00a0<\/strong><\/b><\/p>\n

The key question a buyer often asks is whether he is acquiring a company at the apex of its business cycle or whether the earnings will continue to grow at the previous rate.<\/p>\n

3.\u00a0 Verification of Information<\/strong><\/b><\/p>\n

i.e., the concern for the buyer is whether the information is accurate, timely and relatively unbiased.\u00a0 Has the company allowed for possible product returns or allowed for uncollectible receivables?\u00a0 Is the seller above-board, or are there skeletons in the closet?<\/p>\n

Measuring Earnings<\/strong><\/b><\/p>\n

When a seller talks about earnings, earnings really needs to be defined; e.g., EBIT or EBITDA; last year’s earnings or this year’s projected earnings; EBITDA – CAP X; restated without prerequisites but with add-backs, etc.<\/p>\n

When a buyer is analyzing earnings, is it for one year, three years, interim earnings annualized, combination of reporting periods, projections, etc.?\u00a0 What is the timeframe for measuring earnings and what is the trend of earnings?<\/p>\n

Another concern in measuring earnings in the future is related to what changes might affect earnings, such as increase in rent, family members off the payroll, loss of key customers and\/or vendors, etc.\u00a0 Beware of companies that are locked into long-,term contracts in which they are unable to raise prices or companies in a commodity-type business in which there is unrealistic market pricing.<\/p>\n

Key Considerations<\/strong><\/b><\/p>\n

The following questions are useful to understand the business and thereby value the company more prudently:<\/p>\n