There are many reasons you value your business — some examples include the hard work you put into it, the time and life investment, and general pride in the accomplishment and product. There are also many reasons to determine the economic value of your business — retirement plans, loan applications, shareholder buyouts, divorce and more. To acquire an accurate estimate, manufacturers such as yourself cannot necessarily find the answer on the face of a balance sheet or rely on industry standards. For a reliable estimate, you will need to hire a business valuation professional.
Value from Valuators
Like anything else, if you Google “valuation rules for manufacturers,” a wide range of results will appear. For manufactures, a common rule of thumb is to calculate four to five times the earnings before interest, taxes, depreciation and amortization (EBITDA). Many businesses, however, sell for more or less than this range.
For a purchase offer, this oversimplified formula can serve as a useful sanity check. However, do not rely on it alone; after all, this transaction is possibly the most important business decision you’ll ever face.
For manufacturers, tangible assets — such as receivables, inventory and equipment — are important. Intangibles — such as customer lists, patents, assembled workforce and goodwill — also contribute significant value in a technology-driven, relationship-based market. So, professional valuators generally rely on market- or income-based methods when valuing businesses in the manufacturing sector, looking beyond the cost approach.
The Market Gets the Last Word
Comparable public stocks or private company sales may help value your business under the market approach. However, finding comparables can be tricky. Many small, private manufacturers tend to be “pure players,” whereas public companies may be conglomerates, making meaningful public stock comparisons difficult.
When researching transaction databases, it is essential to filter deals using relevant criteria, such as industrial classification codes, size and location. You may need adjustments to account for differences in financial performance, and to arrive at a cash-equivalent value if comparable transactions include noncash terms and future payouts (such as earnouts or installment payments).
Expected cash flows converted to present value may determine how much investors will pay for a business interest under the income approach. For a variety of items — such as accelerated depreciation rates, market-rate rents and discretionary spending — reported earnings may also need adjustments — such as below-market owners’ compensation or nonessential travel expenses.
A key ingredient under the income approach is the discount rate used to convert future cash flows to their net present value. Discount rates vary depending on an investment’s perceived risk in the marketplace.
Before using financial statements to appraise a business, professional valuators sometimes alter them. The three common types of adjustments are:
- Normalizing. These align the company’s financial statements with GAAP or industry standards. For example, if the company uses the cash (vs. the accrual) accounting method, balance sheet items might be adjusted.
- Nonrecurring and nonoperating items. Historical financial results aren’t as relevant to investors as future potential. Valuators might eliminate discontinued operations and one-time events unless they’re expected to recur.
- Discretionary spending. These adjustments aren’t appropriate for all businesses. For instance, above- or below-market owners’ compensation may be adjusted, but only if the owner will be leaving.
Do you know how much your business is worth today? Though you may have a rough estimate in mind, contact us today and a valuation professional can help provide an objective answer.