Along the road to building the value of a business it is necessary, and indeed, appropriate, to examine the business in a variety of ways. Each provides unique perspective and insight into how a business owner is proceeding along the path to grow the value of the business and if/when it may be ready to sell. Most business owners realize the obvious events that may require a formal valuation: potential sale/acquisition, shareholder dispute, death of a shareholder, gift/estate tax transfer of ownership, etc. A formal business valuation can also be very useful to a business owner when examining internal operations.
So, how does a business owner evaluate their business? And how can advisers or formal business valuations assist owners examining their businesses? There are at least six ways and they are important, regardless of the size of the business. All six of these should be contemplated within a formal business valuation.
- At a Point in Time. The balance sheet and the current period (month or quarter) provide one reference point. If that is the only reference point, however, one never has any real perspective on what is happening to the business.
- Relative to Itself over Time. Businesses exhibit trends in performance that can only be discerned and understood if examined over a period of time, often years.
- Relative to Peer Groups. Many industries have associations or consulting groups that publish industry statistics. These statistics provide a basis for comparing performance relative to companies like the subject company.
- Relative to Budget or Plan. Every company of any size should have a budget for the current year. The act of creating a budget forces management to make commitments about expected performance in light of a company’s position at the beginning of a year and its outlook in the context of its local economy, industry and/or the national economy. Setting a budget creates a commitment to achieve, which is critical to achievement. Most financial performance packages compare actual to budget for the current year.
- Relative to your Unique Potential. Every company has prospects for “potential performance” if things go right and if management performs. If a company has grown at 5% per year in sales and earnings for the last five years, that sounds good on its face. But what if the industry niche has been growing at 10% during that period?
- Relative to Regulatory Expectations or Requirements. Increasingly, companies in many industries are subject to regulations that impact the way business can be done or its profitability.
Originally published in Mercer Capital’s Tennessee Family Law Newsletter, Third Quarter 2018
