By Robert Bates CPA Esq.
Overview
In our current time of economic volatility, social unrest, and political partisanship, simple questions rarely have simple answers. For an owner-operator of a small- to mid-size business, the question of business value in today’s market is increasingly difficult to answer. It is at these times that the team here at HP Accounting feels the need to simplify the process down to the basic premise of what drives value.
In explaining value, HP defaults to the simple metaphor of value a three-legged stool with key drivers that determine value; cash flow, growth, and risk. A simple but dynamic formula for determining value is the capitalization of a business’ normalized cash flows divided by the difference between the discount rate and a long-term growth rate;
V0 = 𝐶𝐹1/(𝑟−𝑔) where;
Benefit stream (𝐶𝐹) to the owners, normalized
Growth rate (𝑔) expected, long term
Risk (𝑟) involved in receiving the benefits in the amounts and time frames anticipated
This article looks at the key drivers that impact value as they relate to these three inputs.
What are the Key Drivers?
An example of what drives value for a hypothetical company is the best way that we can identify and explain these key drivers. Let us start with a company that makes widgets. Let us assume that a hypothetical stand-alone company WDGT Technology makes them. What drives the value of the business; more specifically the three key inputs to value outlined above?
For assessing value, HP has a master list of 26 key value drivers that dive into very specific detail. We have narrowed down this list to the top 10. These 10 drivers help a valuation expert understand the business model, operating history and growth story surrounding the business. This understanding provides the expert support for key assumptions that drive value using the formula above such as long-term growth rate, discount rate, gross and operating margins, balance sheet and incomes statement adjustments. They also help the expert narrow in on a universe of similar transactions that help narrow down comparable exit multiples that get applied to the company’s operating metrics.
The list below looks at these 10 key drivers, what is included in the analysis of each and our assessment of they impact the valuation of WDGT Technology.
The above discussion is just one of many steps in a valuation expert’s process for determining value. However, these 10 key inputs drive the appraiser’s due diligence and set the building blocks for the analysis and report that identifies, supports, and opines to value.
Please contact us to help with your valuation questions:
https://hpaccounting.com/valuation-expert-witness-bay-area-damages-calculation/business-valuation-bay-area/