What is Your Business Worth Today?

HARRY FOX, CPA, CVA

What is your business worth today?

While most business owners have a rough estimate of the fair market value of their investments, many have limited experience in the M&A market. A business valuation professional can provide an objective estimate of value that is based on market data. This can help in many situations, whether for a loan application, a merger, or a shareholder dispute or buyout. You will also need to consult a valuation expert if you are thinking about selling your business for retirement. Here is what you need to know to properly value your business.

Perils of informal value indicators

If you search online for “valuation rules-of-thumb for manufacturers,” a wide range of results will appear. A common formula for manufacturers is four to five times earnings before interest, taxes, depreciation and amortization (EBITDA). However, many businesses sell for more (or less) than this range, depending on market conditions and business-specific characteristics (such as management quality, financial performance and internal risk factors).   

This oversimplified formula can serve as a useful sanity check for a purchase offer, but you should not rely on it alone when selling your business, because it is arguably the most important business decision you will ever face.

Related Read: Is Your Business Getting the Credits It Deserves?

Beyond hard assets

Tangible assets — such as receivables, inventory and equipment — are important to manufacturers. However, in a technology-driven, relationship-based market, intangibles — such as customer lists, patents, assembled workforce and goodwill — also contribute significant value. So, professional valuators generally look beyond the asset approach and, instead, rely on one of two methods when valuing businesses in the manufacturing sector:

1. Market Approach
   Sales of comparable public stocks or private companies may be used to value your business. However, many small, private manufacturers tend to be “pure players,” whereas public companies tend to be conglomerates, making meaningful public stock comparisons difficult.

   When researching transaction databases, it is essential to filter deals using relevant criteria, such as industrial classification codes, size and location. Adjustments may be required to account for differences in financial performance and to arrive at a cash-equivalent value if comparable transactions include noncash terms and future payouts, such as earnouts or installment payments.

2. Income Approach
   Expected future cash flows can be converted to present value to determine how much investors will pay for a business interest. Reported earnings may need to be adjusted for a variety of items, such as accelerated depreciation rates, market-rate rents and discretionary spending.

   A key ingredient under the income approach is the discount rate used to convert future cash flows to their net present value. Discount rates vary depending on an investment’s perceived risk in the marketplace.

Possible adjustments

Sometimes professional valuators tweak financial statements before using them to appraise a business interest. Common types of adjustments are:

Normalizing
These align the company’s financial statements with generally accepted accounting principles or industry standards. For example, if the company uses the cash (vs. the accrual) accounting method, certain financial statement items might need to be adjusted.

Nonrecurring and Nonoperating Items
Historical financial results are not as relevant to investors as future potential. For instance, valuators might eliminate discontinued operations and one-time events unless they are expected to recur.

Discretionary Spending
These adjustments are not appropriate for all businesses. For instance, if the owner will be leaving, above- or below-market owners’ compensation might need to be adjusted.

Beware of Do-It-Yourself Valuations

You may want a valuation for any number of reasons, but your balance sheet or industry rules-of-thumb will not give you enough information to make well-informed business decisions. For an estimate you can count on, hire an experienced business valuation professional.

For more information, contact Harry Fox at [email protected] or 312.670.7444. Visit ORBA.com to learn more about our Manufacturing and Distribution Group.

Five Steps to Ensure Business Continuity Before the Next Crisis

ANDREW DOMBRO, CPA

The COVID-19 pandemic taught us that all manufacturers should have a business continuity plan. Every manufacturer is different, so there is no cookie-cutter formula for business continuity planning. Your plan should outline the immediate steps to be taken in the event of a crisis and be flexible enough to allow your company to adapt to unanticipated scenarios. Here are five best practices to follow in developing a plan.

1. Put Together a Team
   The first step is to put together an interdisciplinary team. It should include people from your production, sales, procurement, HR, IT and finance departments. Consider one person to lead to the team that had the authority to make sure things get done. Local managers should be consulted as part of the plans to get input on plans that may be affected by local issues.

   This group will be responsible for developing the business continuity plan, testing it and keeping it updated. They will also train employees on business continuity procedures and implement the plan in the event of a crisis.

2. Evaluate Your Risks and Essential Services
   Conduct a business impact analysis to understand how various crises would affect your operations. Start by identifying and prioritizing critical manufacturing and business processes and assess the impact on your business should one or more of those processes be disrupted. You may experience issues with staff availability, lack of communication or transportation, power loss, unavailability of supplies and materials.

   Next, examine various threat scenarios and prioritize them based on the probability they will happen and their potential impact. For example, a brief power outage would probably be considered a high-probability, low-impact scenario, while a terrorist attack would likely be a low-probability, high-impact scenario. What about the next pandemic? According to the Center for Global Development, the annual likelihood of a pandemic is 2.5% to 3.3%, which means the probability of another pandemic on the magnitude of COVID-19 in the next 10 years is 22% to 28%.

   Consult with local government and supplier to see if they have continuity/crisis plans to deal with disruptions.

3. Conduct a Gap Analysis
   Do you have an existing business continuity plan? Now is the time to review it and fill in whatever is missing.

   Compare your current plan to what would be needed to achieve your business continuity objectives. This will help you identify your vulnerabilities and evaluate alternatives for sustaining your operations in a crisis.

   This analysis should take a wide view with as many parties providing potential risks and filtered through the interdisciplinary team.

4. Develop Your Plan
   Now you are ready to prepare a written plan that outlines various threat scenarios and includes contingency plans in the event critical resources become unavailable. Be sure the plan lists the steps you would take if key personnel or facilities become unavailable, utility outages occur, equipment is damaged or malfunctions, IT systems become inaccessible, or your supply chain is disrupted.

   For example, the COVID-19 pandemic highlighted the vulnerability of global supply chains to public health emergencies and other disruptions. Your business continuity plan might identify alternative suppliers in more reliable locations that can meet your needs should your usual supply chain channels be unavailable. For this strategy to be effective, you will need to develop relationships with alternative suppliers before a crisis occurs.

   Also create contingency plans in the event a manufacturing facility is shut down. In this scenario, you will need to use an alternate facility or contract a manufacturer to pick up the slack. If critical IT systems become unavailable, identify off-site backups that can be accessed and restored rapidly. What if another health crisis requires a shift to remote work? Your plan should ensure that your IT infrastructure and other systems can accommodate remote workers with minimal interruption.

   The plan should discuss the individuals responsible for implementing the action plan in the event of emergency as well as back up individual, key contacts and support providers.

5. Test and Update Your Plan
   Do not wait for a real-life crisis to find out whether your business continuity plan works. Test it regularly to address any vulnerabilities or to reflect organizational changes or industry developments. Testing methods can range from a “tabletop” exercise — in which your team discusses how it would respond to various threat scenarios — to full-fledged simulations.

   If testing procedures reveal gaps or flaws in your current plan, make the necessary updates and re-test. Continuity planning is a continuous process.

Related Read: Manufacturing Evolving from COVID-19

Be prepared

Building up organizational resilience will allow you to create a quick and effective organization in the event of the crisis and having a plan for minimizing disruptions and resuming operations quickly can make the difference between survival and failure.

For more information, contact Andrew Dombro at [email protected] or 312.670.7444. Visit ORBA.com to learn more about our Manufacturing and Distribution Group.