Valuations: Looking Behind the Curtain

Valuations professionals are often expected to know the value of every business to the penny; however, business appraisal is not an exact science, even as it follows the parameters of a standardized methodology. The analyst’s expertise and judgment are equally important in the process of analyzing value. Each valuation has a certain amount of wiggle room, which is valuable and necessary to the process. While it’s true that a valuation has an element of subjectivity, much of the benefit a client receives from a valuation is from that same subjectivity.

As business valuation experts, we are called upon to exercise our professional judgment within fairly narrowly defined constraints. In order to comply with the accepted standards of valuation practice, experts must consider certain approaches to valuation, and within each of those approaches, analyze all of the relevant factors. Some of those factors are little more than a full consideration of the historical operating results of the subject company. Other factors are more dependent on the experience of the analyst, but may provide as much insight to value as all of the required methodologies combined.

So, given that we, as valuation professionals, are called upon to consider whatever factors weigh on value, what factors do we consider important? Allow us to show you some of what we do “behind the curtain,” and why that wiggle room is necessary.

In addition to considering a company’s cash flow and the valuation multiples involving similar companies, a proper analysis must consider at least the following factors:

• Location, size, and maturity of company

• Products and services offered

• Customer base and competition

• Quality of cash flow and factors driving it

• Experience/depth of management and relations with employees

• Quality of facilities and underlying operating assets

• Position in the industry

• Quality of inventory

• Supplier stability and relationships

• Market elasticity

Each of these factors should be considered in the context of the analyst’s own experience. For example, in analyzing an automobile dealership, we would consider not only the company’s historical financial performance compared to other similarly-sized dealerships in the same geographic area, but also the current interest-rate environment, gasoline price trends as they relate to automobile purchases, the types of cars sold, the local competitive landscape, location, debt capacity and utilization, sales force and employee turnover, as well as many other factors.

Some of the factors that are most relevant may not be part of the required considerations. For instance, a dealership that sells primarily large, expensive vehicles with poor fuel economy would be negatively affected by an economy experiencing increasing gas prices and high interest and unemployment rates.

It is often these “nonfinancial” issues that bear most strongly on value. Just as a company with incredible historical cash flow from a disappearing customer base has little value, a moderately profitable company with a growing customer base and important strategic alliances with its suppliers may have a value much higher than that reflected by its history. A true expert will apply the standard methodology in a way that recognizes the existing wiggle room and recognizes those factors that drive the value of a company. In other words, a thorough valuation clears the smoke, removes the mirrors, and invites the outside world to look behind the curtain.

If you have comments or questions about this article, or would like more information on this subject matter, please contact us.
Daniel Kvarnberg

Valuation
dkvarnberg@pcecompanies.com
Orlando Area Office

407-621-2100 (main)
407-621-2132 (direct)
407-621-2199 (fax)