Calculation of Value – Financial Snapshot
Generally, the analysis of the company’s financial statements [the income statements and balance sheets] is performed in order to assist the business appraiser in measuring trends, identifying the assets and liabilities of the company, and in comparing the financial performance and condition of the company to other companies in the same or similar industry. This process is useful because it helps the valuator understand, evaluate, and communicate the value and risk drivers present in the company. For this calculation report, we focus the analysis on the adjusted and projected earnings, as well as the assets & liabilities included in the calculation of value.
Adjusted Earnings: The process of estimating the value of a business frequently requires the adjustment of certain financial statements to free them from the influence of accounting elections that were made to minimize tax liability; and to restate them in such a way as to depict the true economic performance and condition of the company. Typical adjustments for small to mid-size businesses include excess officer compensation, owner’s benefits or “perks”, one-time expenses, or other non- related businesses expenses and/or revenue.
This Calculation “normalizes” earnings by starting with unadjusted EBITDA [earnings before interest, taxes, depreciation, and amortization]; and then discretionary or non-operating expenses are added back to arrive at Seller’s Discretionary Earnings [SDE]. Most “main-street” and lower middle-market businesses typically sell based on a multiple of SDE. Fair market salary and benefits for an owner/operator (or manager/CEO – depending on the size of the company) are then deducted to arrive at “Adjusted EBITDA”. Most middle market to larger privately held businesses typically sell based on a multiple of Adjusted EBITDA.
Projected Earnings: The next step is to project out earnings for the next 4 years. The first step is to use the historical performance to set a “base period” for future growth. The historical periods are weighted based on a confidence level. For instance, if the analyst believes that the last full year is a good representation of future performance, he or she will weight the last full year at 100%. Or, if historical performance is inconsistent, an “equal” weighting may be more appropriate.
The next step is to add growth to the base year to arrive at a reasonable projection for the next 4 years. The first year should take into consideration the most likely scenario for year 1. Interim performance, year over year performance, and annualized performance can be considered. Year’s 2-4 should be based on a realistic pro-forma model (not unrealistic assumptions).
Adjusted Balance Sheet: Typically the balance sheet is analyzed for changes in working capital and fixed assets (capital expenditures) and performance ratios (liquidity, turnover, debt capacity, etc.); however, this process has been omitted in this calculation report. We simply adjust for what assets and liabilities are included in the calculated value.
It should be noted that instead of calculating the value of the “equity” or the “assets” of the business, we are simply indicating what assets and liabilities are included in the value/sale. There are a number of ways to structure a sale and many different tax consequences for buyers/sellers. The majority of smaller to mid-market businesses will sell based on an asset transaction (inventory, fixed assets, and goodwill). We’ve simply developed a model to start with this “asset value”, then add additional working capital or deduct liabilities included. Any buyer or seller should discuss purchase price allocations and tax consequences with their CPA.
Price for Calculation of Value
While typical business appraisals often start at $5,000, the cost of our Calculation of Value is a fraction of this cost. Click HERE to see a sample report. Contact Tom MacPherson, at the Charlotte office, for the cost of a Calculation of Value and what we need to prepare one.
The Summit Acquisitions Group — Business Brokers and M&A Advisors — specializes in the sale, appraisal, and financing of privately owned companies ranging in valuation from $750,000 to $25,000,000. Contact their offices in Atlanta, GA or Charlotte, NC for a free consultation.