Archive for March, 2012

One of the most important choices you can make when valuing a company is the proper selection of earnings basis. The idea is to capture the true earning power of the company. In virtually all professionally done business appraisals the earnings basis is some measure of cash flow.

The typical choice is the net cash flow. The reason net cash flow is so popular is that it represents the part of overall business earnings that can be taken out by the owners and debt holders without impairing the continued operations.

One of the key components of net cash flow is changes in working capital. Increase in working capital indicates that the management is investing resources in the short term. This exerts a drain on available cash flow from the operating, financing and other investment activities.

Conversely, a negative change in working capital over a period of time shows that the business has relied upon short term borrowing to finance its operations. This generally results in a cash flow increase.

When changes in working capital are significant, you can see net cash flow figures that may be surprising. Reviewing anomalous cash flow fluctuations is especially important when generating an earnings forecast for such valuation methods as the discounted cash flow.

A single period of above or below the norm earnings in your forecast may be enough to skew your business valuation results, especially if it occurs early in the projection. Some questions you may ponder are:

  • Does the working capital investment lead to increased sales and profitability down the road?
  • Is short term vendor borrowing a wise strategy to finance operations?
  • Does the company risk profile change as a result?
  • How do these management decisions affect business value?

Business valuation based on cash flow

See how to use a cash flow forecast and business risk assessment in your business valuation.

If you need to value a tour operator company, here are some key industry statistics to consider:

Classified under the SIC code 4725 and NAICS 561520, there are 2,993 firms in the US alone. These tour operators generate a combined annual revenue of $4,397M with 32,125 staff.

Yet the average tour operator business is a small company with annual sales of $4,397,000 and 11 employees.

The industry sector revenues have grown about 38% from $3,190M in 2002 to over $4,397 in 2007. However the number of firms has declined 4.8% in the same period. Employment has also contracted about 0.71%.

The successful tour operators have grown larger and more efficient with revenue per employee $135,852; up 39% from 2002.

Valuation of tour operators – market approach

Such established successful companies are frequent acquisition targets. You can use data on comparable tour operator business sales as a basis to estimate the market value of your company.

The usual tools are valuation multiples calculated from recent tour operator company sales. The valuation multiples are ratios that relate the business selling prices to their financial performance metrics. Some common valuation multiples used in valuing tour operators are:

Example: Valuation of a tour operator business using multiples

To demonstrate the idea, let’s take a look at an average tour operator business with the following annual financials:

  • Revenue: $4,400,000
  • SDCF: $350,000
  • Furniture, fixtures and equipment (FF&E) assets: $122,000

Now we apply a set of reasonable valuation multiples to calculate the business value below:

Multiple Multiple value Business value
Business value to gross revenues 0.148 $651,200
Business value to SDCF 2.280 $798,000
Business value to FF&E assets 5.968 $728,096
Average Business Value $725,765

Why such a spread of business value results across the different valuation multiples? This depends on how well our sample company performance compares to other tour operators.

In this example the company is quite profitable and generates above average returns on its fixed assets. However, its gross revenues are just average resulting in a lower business value estimate figure.

Valuation Multiples for Tour Operators

Recent sales of tour operator companies are a great source of valuation multiples. They help you value your business based on its gross revenues, net sales, profits, EBITDA, cash flow and assets.

See Example »

Three cheers again for the ValuAdder engineering team for their outstanding work on the all new ValuAdder V7 product.

Designed on top of the leading edge Scala and Java technology, ValuAdder V7 brings an important new valuation tool in 2012 – the employee stock option (ESO) valuation system.

Hull-White binomial model for ESO valuation

The tool implements the standard Hull-White Binomial Model to value executive stock options. One of the key challenges in valuing such options is estimation of the underlying stock price volatility, especially for a privately owned firm whose stock does not trade on the open market.

That is where the powerful business valuation methods available in ValuAdder V7 come in. You can determine the value of a company over a period of time and calculate the per-share stock price at each point.

Stock price volatility estimation for private companies

Using the ValuAdder stock option valuation tool you can then determine the stock price volatility as the variance of the stock returns. Of course, for a public company stock, the actual market prices observed can be used directly. You can also use guideline public companies for comparative stock price volatility estimation.

A set of key parameters to value the employee stock options

The ValuAdder employee stock options valuation tool lets you account for a set of key option grant parameters:

  • Option exercise or strike price
  • Current stock price
  • Vesting period
  • Option expiration time
  • Interest the company pays on its debt capital
  • Dividend payout rate
  • The expected rate at which the employees leave the firm

Stock option sensitivity analysis

Need to study how these various parameters affect the value of ESOs? Not a problem! You can run a number of what-if scenarios to see how sensitive the stock option value is to any or all of these key factors.

Binomial Model endorsed by key accounting standards

We are very excited about this addition to the ValuAdder business valuation system product. Not only can employees and key decision makers determine the value of executive stock options easily, the Binomial Model used in ValuAdder is the recommended way to value employee stock options.

Companies need to account for this compensation on their financial statements. In fact, the Binomial Model of option valuation is endorsed by the Financial Accounting Standards Board (FASB) Statement No 123 R and the International Financial Reporting Standards (IFRS).

Employee Stock Option Valuation Tools