Often at first glance the process of valuing your business can appear time consuming and intimidating. At Valuecruncher we have streamlined the process to the point where all that is required is a 1 page Excel worksheet and Valuecruncher will provide you with a 5 page valuation report within 48 hours. This post outlines the 5 steps involved in the Valuecruncher valuation process.
1. Collect the relevant information
The starting point for Valuecruncher valuing a business is the latest financial statements. The business’ accountant should be able to provide you with a copy of these.
Financial statements include:
1. Profit & Loss Statement
2. Statement of Cash Flows
3. Balance Sheet
Some accounting jurisdictions don’t require a Statement of Cash Flows – that isn’t a problem. The profit and loss statement and balance sheet are the key starting point for completing the input sheet for a Valuecruncher valuation. The only component we require from the Statement of Cash Flows is the capital expenditure for the business. If there are any questions about the relevant information required – please don’t hesitate to contact the Valuecruncher team (http://www.valuecruncher.com/contact/).
2. Input relevant information into the Valuecruncher 1-page input sheet
Profit and Loss Statement
We start with the Profit and Loss Statement. We are interested in four inputs from the Profit and Loss Statement and information on capital expenditure: revenues, profitability, depreciation and amortisation charges, and capital expenditure.
Compiling the Valuecruncher valuation input sheet: Profit and Loss Statement items – Example
Cash Flow Statement
The Cash Flow Statement provides the information required to compile the capital expenditure inputs.
Compiling the Valuecruncher valuation input sheet: Cash Flow Statement items - Example
Projections
The next step is then projecting forward key numbers – revenues, EBIT, depreciation and capital expenditure. Valuation is a forward-looking exercise, even if the business mature and stable it is still important to compile projections. Valuation is based on future performance of the business. This may be the same as the current performance but it can also be materially, or slightly, different – either better or worse. For a Valuecruncher valuation the Profit and Loss Statement projections are the key input. The key projections required for valuation purposes are revenues, profitability, depreciation and capital expenditure.
Each business is different and has different expectations of future performance. If the business is stable and not expecting to grow significantly then making projections is reasonably straightforward. When the business is going through significant growth or the market the business operates in is uncertain – then the process is slightly more difficult. It is however a good process for a business to look at what financial results it expects over coming years. Making financial projections is subjective exercise that reflects the best estimate of an uncertain future. Don’t be intimidated by the uncertainty involved in compiling projections, they are only meant to represent the best estimate. Valuecruncher valuation reports provides sensitivity analysis that illustrates how alternative projections impact on the business valuation.
At Valuecruncher we often see a reasonably high-level approach taken to valuation – which is just fine. It is typical for a business owner to say something like “we expect revenues to grow at 10% per annum over each of the next three years with profitability (at the EBIT level) margin (as a percentage) remaining the same as it is today. We expect depreciation and amortisation to remain about where they are today. We will be spending an additional $50,000 in capital expenditure next year but then expect capital expenditure to remain at the current level”. With information even at that simplified level – the Valuecruncher input sheet can be completed. If a business has detailed financial projections then these should be utilised. Most businesses do not however have detailed projections. High-level assumptions are all that is required for completing the Valuecruncher input sheet.
Some more tips for making projections
Revenue projections – a simplified approach to revenue projections involves estimating the short-term (next 3 years) revenue growth as a percentage. The estimated percentage growth can be based on historic growth rates or incorporate any expansion plans the business has. Valuecruncher can assist to covert projected growth rates into actual revenue figures if required.
Profitability projections – the best starting point for projecting profitability is the current levels. If the business is planning to introduce new technology or has recently increased production capacity it is possible that profitability will increase in the future – but there is usually an increase in costs associated with additional profitability. If a business has an owner that works in the business at a below market salary – this should be adjusted to market levels.
Businesses run at break-even – Valuecruncher often sees businesses that are run at break-even. Our approach to valuation with these companies is to look what the level of profitability that companies in the industry typically operate at. Then we will extrapolate that industry average profit performance to the business’ sales. This approach provides a reasonable assessment of the value of the business even when the business is operating at break-even. We have a table of average industry EBIT margins (click here). If you are unsure or have questions about the appropriate EBIT margin to potentially use Valuecruncher is happy provide assistance.
Capital expenditure projections – when estimating capital expenditure required by a business it is important to consider the current status of the business’ assets and any investment that may be required for replacements or upgrades. Other examples of potential capital expenditure include research and development expenses. The Valuecruncher input sheet also requires a terminal capital expenditure amount – this is simply the “typical” level of capital expenditure that the business would anticipate into the future. We include this amount to ensure that capital expenditure figures do not get inflated by current spending and truly reflect the on-going capital expenditure of the business.
Depreciation – the starting point for projecting the depreciation charge is the current amount. If the business plans to invest in fixed assets the depreciation charge can be expected remain constant and potentially increase. If the business has no plans to invest in its assets the depreciation charge can be expected to decrease.
Balance Sheet
The Balance Sheet inputs for the Valuecruncher valuation are only historic numbers – there are no projections required.
Compiling the Valuecruncher valuation input sheet: Balance Sheet items – Example
3. The valuation calculation
Valuecruncher incorporates the projections and balance sheet values supplied by client (via the input sheet) into a discounted cash flow (DCF) model. Valuecruncher estimates the long-term growth rate and the required rate of return for the business. Valuecruncher will calculate the sensitivity of the valuation to the projected revenue and profitability supplied by the client. The sensitivity analysis provides an indicative valuation range. The DCF valuation is supplemented by comparable company analysis and an asset based valuation.
Comparable Company Analysis – Valuecruncher has an extensive database of information on companies in a wide range of industries around the world. Using the database Valuecruncher will compare the DCF valuation output with the implied valuation based on prices comparable companies have sold for and trading prices of publicly listed companies. Comparable company analysis is a relative measure of value that provides a check for the DCF valuation. The comparable company analysis does not incorporate the unique features and opportunities of a business but provides a market-based estimate of value.
Asset Analysis – Valuecruncher calculates the value of the business’ net tangible assets (NTA). This is a purely accounting based measure that incorporates the current book value of the business’ assets. NTA is not a forward looking approach and it does not evaluate the earning potential of the assets. The NTA methodology is often impacted by the accounting treatment of assets (i.e. depreciation policies).
These three valuation methodologies form the cornerstone of the valuation frameworks used in global investment banks and major accounting firms.
4. Valuecruncher review the valuation
Upon completing the valuation calculations a member of the Valuecruncher team will independently review the valuation including the projections and inputs provided by the client and the assumptions applied.
Common issues identified with valuations include:
- Client revenue projections are overly optimistic reflecting a “best case” scenario opposed to an expected case.
- EBIT margins are too high because all costs are not being incorporated. Often the “actual” owner’s salary is not fully reflected in the financial statements.
- EBIT margins are too low because the company is being run at breakeven point with the owner expensing items through the business that are not part of the business’ operations.
- Projected capital expenditure does not reflect the investment required to generate the projected growth.
If Valuecruncher identifies an issue that materially impacts the valuation the client will be contacted to clarify the issue before the valuation report is generated.
5. Valuecruncher provide the valuation report
Valuecruncher compiles the inputs provided and the valuation outputs into a five-page valuation report. The valuation is expressed as an indicative range based on the DCF sensitivity analysis with a mid-point reflecting the inputs and projections supplied by the client; this is supplemented by the implied comparable company and NTA valuations. The report includes a summary of the valuation outputs and highlights any assumptions that may need to be reviewed. If after inspecting the report and assessing any potential issues raised by Valuecruncher the client wishes to revise the initial inputs provided, Valuecruncher will provide an updated valuation report for no additional fee.
Get a Valuecruncher valuation - click here
Download a PDF version of 5 Steps to Valuing a Business - click here
