When it comes to business valuation, forecasting the business future financial performance is one of the most challenging, yet necessary tasks. Business value is about risk and returns going forward. Assessing how well you expect the business to do is at the core of establishing its value.
There are two ways to prepare the assumptions about the possible future financial performance of the company. One approach is for the business appraiser to come up with his or her best assessment. An alternative is to use the business management estimates.
Independent business valuations
If you expect the business appraisal to be subjected to serious scrutiny, objectivity of an independent business appraiser is key. This argues in favor of letting the appraiser do the forecasts of business earnings and expenses.
Rosy forecasts and overstated business value
Business management created financials are often rosy and based on aggressive goals. Many business people tend to underestimate the potential pitfalls that sharply limit the company’s ability to achieve such lofty objectives. This is especially the case when a company is facing serious headwinds currently, but hopes the coast will clear in the near future. More trouble ahead may well be overlooked.
The effect of these projections changes your business valuation result significantly. Take, for example, the discounted cash flow valuation method. The forecast of future earnings is a key input. If your cash flow forecast is unrealistic, especially in the early years, the value of the company will be overstated.
Unrealistic business valuation – uncomfortable questions
Valuations that are unexpectedly high are sure to generate skepticism from savvy business people and professional reviewers. An appraiser could state in the business valuation report that the assumptions of company’s management have been used in the analysis. The reader is put on notice, but is still left wondering why the business appraiser went with the management’s point of view.
Independent business earnings forecast – the objectivity advantage
If the business appraiser creates the earnings forecast from scratch, the readers of the business valuation report would likely expect a less enthusiastic but more sober set of assumptions. After all, business appraiser is not bound to endorse high expectations, but rather expected to provide a realistic measurement of what the business is worth.
Has the business appraiser covered all the angles?
The downside is that the business appraiser may not have the in-depth knowledge of the company to make the best projections. As an outsider, you may lack the understanding of the value drivers that can support the earnings growth the company’s management expects.
So what is the best approach? No clear answer exists. Perhaps close interaction between the experienced company management team and business appraiser is the best strategy.