Archive for July, 2011

If you do your work on an Apple Mac computer, you may have heard the big news – the latest Mac OS X Lion version of the operating system has been released on July 20, 2011. Packing over 250 new features that enhance your productivity, Mac Lion is sure to impress the most demanding users.

Do you need to conduct a business valuation on your Mac? Then you will be pleased to know that all ValuAdder business valuation software tools are fully supported and available for Mac OS X Lion.

The powerful new features of Mac Lion, such as the much improved multi-touch functionality, make it even easier to use ValuAdder in your business appraisal projects.

Mission Control can be used to easily switch between various valuation scenarios you create with ValuAdder software – each appearing in its own window. Use the gestures on your Mac Lion touch pad to instantly see all the valuation scenarios you have created.

Or quickly scroll through the Learning and Information Center content using the two-finger scroll gesture. Come back to your appraisal report with a single swipe. Resume your valuation analysis work right where you left off. And the new Auto Save feature in Lion makes sure your scenarios are always saved and available whenever you need them.

Don’t forget the Versions feature that lets you create multiple revisions of the same valuation scenario. You can either create new ValuAdder valuation scenarios, update the current valuation calculation with inputs from a previously saved one, or start a new analysis – all in just a few moments.

ValuAdder scenario files are in the industry-standard XML format. Need to communicate with your colleagues or clients? Use AirDrop to share your business valuation results wirelessly during reviews or negotiations.

Any business valuation method in ValuAdder has a report attached to it. You can create the report in a PDF format, print it or export your analysis as a spreadsheet file. Then email it instantly.

Need to prepare a professional business valuation report? With ValuAdder Report Builder you have quite a number of choices for creating a standards-compliant high quality report. Just create a pre-configured report template and open it for editing in a number of office productivity apps available on Mac Lion, including Office Mac, iWork or the Open Source LibreOffice productivity suite.

Business Valuation with ValuAdder Tools

Have you considered using the Discounted Cash Flow method in your business valuation? If so, much of the work is in creating reliable business earnings forecasts and assessing its risk.

An often overlooked part of the discounted cash flow method analysis is estimation of the long-term business earnings growth rate. This important factor affects the so-called terminal value of the business. It is the residual value of a going concern that is added on top of discounted cash flows when calculating the overall business value.

If you take a closer look at the terminal value formula, you will see that the business earnings growth rate appears in the denominator. In fact, this equals the business capitalization rate. Note that the cap rate is the difference between the company’s discount rate and earnings growth.

One common situation the business appraisers face is how to accurately estimate this earnings growth number. Should it be based in some way on your cash flows forecast? Or does the answer lie elsewhere?

A number of businesses, especially young companies, may experience periods of rapid earnings growth. If you base your long-term earnings growth estimate on this, you may come up with a number that exceeds the business discount rate.

Mathematically this produces a negative capitalization rate. In economic terms, this means that the business cost of capital is below its long-term earnings growth prospects, an impossible scenario.

The net result is that the terminal value becomes a negative number and the discounted cash flow analysis breaks down. What this tells us is that the long-term earnings growth rate has been overestimated.

In the short run, your business earnings may well grow rapidly. However, as the company matures a number of factors act to limit its growth prospects. New competitors enter the market exerting a downward pressure on the company’s profits. Market saturation demands that the firm look for additional income elsewhere. Products and services eventually need upgrading which calls for capital infusions further reducing the available cash flow from the business operations.

So where should you look for guidance in assessing the business long-term earnings growth? Consider a few possibilities:

  • Look at the overall economic situation both regionally and nationally. Is your earnings growth expectation realistic against this background?
  • Estimate the industry sector growth rates. Are your projections consistent with the industry peers’ performance?
  • Carefully review your cash flow forecast. Do you anticipate some growth spurt to occur that should be followed by a period of more stable earnings?

Remember that the key reason the terminal value is added to the discounted cash flow valuation is that you may have trouble coming up with a reliable earnings forecast too far into the future.

This uncertainty would call for a conservative estimation of the business profitability going forward. And it usually means a sensible earnings growth estimate and a more defensible business valuation result.

Business Valuation by Discounting Cash Flows

One of the central valuation methods under the income approach is the Discounted Cash Flow technique. To apply this method in your business valuation you would need to work up the following key inputs:

  • Forecast of business cash flows
  • Discount rate measuring the business risk
  • Business long-term value, known as the terminal value

While the future cash flows and business risk assessment usually come from the business financial plan, the calculation of the terminal value requires a leap of faith. The idea is that you can predict business earnings only so far into the future.

You may feel that the business will continue running as a going concern but have difficulty predicting its future earnings. The discounted cash flow method lets you get around this problem by including the terminal value in the calculation. This represents the residual value of the business beyond the earnings forecast period.

There are a number of situations that business owners or their advisors may handle differently in this respect. For example, they may have a clear plan toward selling the business and the kind of money the transaction will likely bring.

On the other hand, the owners may decide to wind up the operations after some time and either sell the remaining assets or use them up prior to the shutdown.

Each of these scenarios may greatly affect what the business is worth today. Other things being equal, the difference is in the terminal value of the company.

If the firm is to continue as a going concern, you can capitalize the future earnings accounting for the expected earnings growth rate and calculate the terminal value.

Alternatively, you can incorporate the future business selling price directly into your valuation. In other words, the residual business value to the current owners is the discounted future selling price.

If the business is to be closed after some time, then the terminal value is just the salvage value of the remaining business assets. If you do not expect significant assets to remain on hand at that point in time, then the terminal value is zero.

Example: Long term planning and business value

Let’s see how these considerations can affect the result of your business valuation. Consider an example company with the following 5 year net cash flow forecast:

  • Year 1: $95,377
  • Year 2: $101,231
  • Year 3: $107,085
  • Year 4: $112,940
  • Year 5: $118,794

Note that the average cash flow growth rate for this business is 5.47% annually.

We further assess the business risk and calculate the discount rate of 29.58% and capitalization rate of 24.11%. Next, consider the business value under each long-term scenario as follows:

Case 1: Valuation of a business as a going concern

Here we make the assumption that the company will continue operating as usual past the earnings forecast period. The terminal value is then calculated to be $519,605. Applying the discounted cash flow valuation to these inputs gives us the following business value result:

Business value as a going concern: $397,913

Case 2: Valuation of a business that is sold at the end of the earnings forecast period

Under this scenario, the business owners believe that they can sell the business for $750,000 five years down the road. The resulting business valuation now becomes:

Business value: $460,978

Case 3: Business valuation for a company that is shut down in 5 years

In this situation the business owners opt to close the business at the end of the earnings forecast period. They intend to use up the business assets so that they will have no salvage value then. The company is basically worth the present value of the cash flows expected from the business over the 5 year period. Using the discounted cash flow method again, we get the following result:

Business value: $255,686

Business value depends on your assumptions

Note the sharp differences in the business valuation results we get under these different scenarios. Clearly, the decisions you make today can have far reaching consequences on what the business is worth.

Business Valuation by Discounting its Cash Flow