Assessing Company Worth in a Business Valuation
As a general rule, large publicly held companies must formally determine the business’ worth when placing the company on a stock exchange. Entering the stock exchange is a massive milestone for many growing companies. Following through on that milestone is not simple, and it is one of the primary reasons that a business might need a full assessment of its company worth.
There are many reasons to assess a company’s worth, including seeking out investors or access loans. Closely held companies and publicly traded companies have different methods and reasons for obtaining a business valuation.
Complying with Generally Accepted Accounting Principles
Those companies present their financial statements created in compliance with Generally Accepted Accounting Principles or GAAP. The reports circulate among the public and banks to acquire investors or obtain loans. Those statements are typically part of the larger picture of developing a cohesive business valuation before entering a stock exchange. Not every company needs to go through this same public process.
A Special Note for Smaller Companies
Smaller, privately-owned companies do not need to provide the public with any financial information. These companies only need to prepare tax returns annually. However, many factors of the generally accepted accounting principles could assist smaller businesses during a valuation.
There are Generally Accepted Accounting Principles for small businesses, or Small GAAP. Privately held companies still do not need to use GAAP or Small GAAP. However, private companies may choose to use GAAP-based financial reporting because of the credibility and conciseness of the financial information. Even when privately held companies adopt GAAP best practices, it does not ensure that any particular financial document would showcase the company’s value.
Why Businesses Can’t Rely on Tax Returns to Determine Company Worth Valuations
The income figures from a company’s tax return will accurately represent revenue from all sources. However, the expenses that appear on the returns make it unsuitable for use anywhere else. Items such as depreciation, discretionary spending, owner’s perks, and pensions lower the net profit figures. Sometimes tax returns can show net profit figures past zero.
Presenting a buyer or bank with a financial statement showing little or no profit is simply unacceptable. When selling a business or applying for credit, a small profit won’t benefit the owner.
Buyers will not likely purchase a business that has a minimum profit or losses on a tax return. It is also unlikely that banks would lend a borrower money unless there were special situations. Part of the complication of using income figures from tax returns is that the IRS code mainly encourages business owners to show as low a profit as possible. Tax returns, P&L statements, and other documents should accurately showcase revenues and expenses. None of those documents accurately represent company worth or value.
Businesses’ financial documents don’t represent:
- Customer concentration
- Product concentration
- Industry concentration
- Management team abilities and skill
- Competitive advantage
These factors dramatically change the value or worth of a company. For example, a company that seems more financially stable than their competitor may only have a few customers making up 50% of their annual sales. If that owner sold the business, the business could lose those customers. Through evaluating the company’s worth and adjusting accordingly to show more than the simple numbers on a financial document, it’s possible that owners, potential buyers, and investors can all make better decisions.
What Critical Elements Help to Evaluate Company Worth
There are a variety of accounting methods and techniques used in evaluating a businesses’ value—some critical elements, including recasting the balance sheet or income statement. The purpose of recasting these documents is to expose factors of the company’s value that aren’t represented on paper. Assets and intangible assets may present more value to the company than the numbers representing them on paper.
Recasting the Balance Sheet
The figures on a company’s balance sheet attached to a tax return are so inaccurate that only the government finds them useful. Other parties, such as potential buyers and banks, require more accurate information to make their determinations. The balance sheet computed according to tax rules is outright inaccurate. Assets that undergo depreciation according to tax rules don’t showcase the true value of these assets to the company.
In reality, assets may present much more value to the business or even be vital to the company earning money in the future.
Another key issue with the balance sheet is that the inventory expressed on the balance sheet would represent a snapshot of the inventory, not necessarily the current inventory at the time when the company needs to establish its worth. Most private companies do not make an effort to maintain accurate inventory numbers.
To accurately adjust the balance sheet, the recasting would adjust real estate and other assets, obsolete inventory, accounts receivable, loans to the owner, equipment not on the books, and goodwill. The recast statement would give banks and investors a better idea of what the company actually owns and its realistic company worth.
Typical Adjustments
One of the most common ways to determine fair market value is to depreciate replacement costs of assets or to adjust liquid assets. Typical adjustments focus on liquid assets such as short-term investments and cash.
Experts will also work to adjust business liabilities. Any below-market interest debt would undergo adjustment to reflect current market value or assume that payments are under ideal conditions. These adjustments can effectively reduce the current value of the liability.
The primary adjustments that business owners want to draw attention to is the off-balance sheet adjustments. Those adjustments include intangible assets as well as contingent liabilities. Off-balance sheet assets can include compliance costs, intellectual property, the value of their teams, and more. There are many opportunities to build the company’s worth through intangible asset adjustments.
Recasting the Income Statement and Cash Flow
Recasting the income statement and cash flow is another critical method to accurately representing the company’s worth. It often provides more favorable numbers for the seller, buyer, and lender.
To recast financial statements, a valuation expert would adjust the following elements to reflect reality:
- Owner salaries
- Unrecorded expenses such as vacation time and bonus pay
- Non-recurring expenses
- Non-recurring income
- Investments
- Non-operating expenses
- Interest payments
- Depreciation expenses
- Rent expenses
- Discretionary expenses
- Pensions
These elements can dramatically change during the recasting process. The process often involves finding expenses that impact the business but don’t typically appear on financial documents. After assessing these factors, a professional could access a clearer picture of the company’s income and cash flow.
After adjusting for these elements in financial statements will produce a more accurate and reliable presentation of income. Then, experts would use more reliable income information to calculate the company’s worth.
Potential buyers, investors, and banks can use the adjusted income statement to better gauge the activity of the business. Even business owners can benefit from the recast income statement by using it to make their business decisions.
The normalized net operating cash flow shows the adjusted income statement for certain items. Some specific items, such as non-cash related or unusual items.
The adjusted net cash flow will show the earnings before the interest, depreciation, and taxes. That means it includes the additions or subtractions for items, including one-time or one-off expenses.
The earnings recast is often necessary to show the real profitability and real income of the company. Those are two vital components to determining the company’s worth and presenting that information to sell the business, take it public, or find loans or investors.
Accessing Professional Help for Reliable and Accurate Company Worth Assessments
If your business is up for sale, if you’re trying to bring in investors, representing your business against the IRS, or acquiring a bank loan, then you need a formal review of your company’s worth. However, business owners should regularly review their company’s worth even without these situations. Privately owned businesses are in a unique position where their traditional accounting practices may not assist them in decision making throughout the year.
Undergoing regularly company worth assessments can certainly help the owner of a private business, big or small. However, it is often difficult and time-consuming to assess value or company worth.
Publicly traded companies may need regular company valuations for a variety of reasons. In the case of a publicly-traded company or a private business, it is vital to have a professional evaluate the company’s worth. There are a number of ways to calculate the company’s worth and assess the opportunities and liabilities, but they all require a professional to closely evaluate the company’s current financial documents.
To start determining your company’s worth, contact American Fortune, and speak with a business valuation expert. Our team of experts work with company worth evaluations daily and have an in-depth understanding of the market. Reach our office at (800) 248-0615.
Recasting Financial Statements For Company Worth and Valuation Needs to be Performed by an Experienced and Qualified Business Valuations Professional.
For accurate, defensible and low cost Company Worth and Valuation Reports contact American Fortune Business Valuation Services at (800) – 248 – 0615.