Business people, investors, and creditors pore over financial statements to make decisions. If you are a business owner, you look at the company’s financials to see how well it has done, and what investments are needed to achieve its goals in the future. Investors, of course, want to know if the value of their investment is growing. And creditors are interested to make sure their money is safe.
Notice that all these needs depend upon the future outlook for the company. Will the business generate enough income to pay its owners? Will the growth in business earnings justify the money invested? Will the company have enough funds to pay off its loans?
The central question is: where does all this money come from? Firstly, from business revenues. Revenues must be compared against the business operating expenses as well as the capital required to support its sales and expansion plans.
So how can a business meet its cash requirements? Here is the short list:
- By generating cash flows from operations
- By selling shares of its stock
- By borrowing from creditors
- By selling some of its assets
If you consider borrowing from a commercial lender, you will quickly discover that their view of business comes with a large dose of skepticism. Bankers expect the worst, so they try to protect their interest assuming the worst case scenario for the company. Should the business cash flow fall too low, how will the loan be repaid?
The typical answer is by selling some business assets. That’s why the lender is likely very interested in the value of business assets. Note that this is very different from the book value carried on company’s financial statements. The real question for the lender is this: should the company fail to come up with cash for loan repayment from its profits, what can certain business assets fetch on the market if offered for sale?
In other words, the lender is interested in the liquidation value of business assets. The book value of depreciated assets shown on the company’s books is not helpful here.
As the saying goes, if you are not selling your business assets, you are buying them. The market value of these assets is what your company owns. Find out what the assets are worth before asking a banker for a loan.More on Valuation