For many manufacturing business owners, the value of the
business becomes a focal point only when they're preparing to sell or retire.
However, a professional valuation can be used as a strategic tool throughout a
manufacturing business's life. If you've been considering having your business
professionally valued, here's what you need to know.
2 common valuation methods
Tangible assets — such as receivables, inventory and equipment —
are important to manufacturers. But, in a technology-driven, relationship-based
market, intangibles — such as customer lists, patents, assembled workforce and
goodwill — also contribute significant value. To effectively address the value
of intangibles, a professional valuator will generally rely on one of two
methods when valuing businesses in the manufacturing sector:
1. Market approach.
Sales of comparable public stocks or private companies may be used to value
your business. However, many small, private manufacturers tend to be "pure
players," whereas public companies are often conglomerates, making meaningful
public stock comparisons difficult.
When researching transaction databases, it's essential to filter
deals using relevant criteria, such as industrial classification codes, size
and location. Adjustments may be required 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.
2. Income approach.
Expected future cash flows can be converted to present value to determine how
much investors will pay for a business interest. Reported earnings may need to
be adjusted for a variety of items, such as accelerated depreciation rates,
market-rate rents and discretionary spending.
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.
Adjustments to financial statements
Sometimes professional valuators tweak financial statements
before using them in a business valuation. Common types of adjustments are:
Normalizing.
These adjustments align the company's financial statements with U.S. Generally
Accepted Accounting Principles or industry standards. For example, if the
company uses the cash (vs. the accrual) accounting method, certain financial
statement items might need to be adjusted.
Nonrecurring and nonoperating items.
Historical financial results aren't as relevant to investors as future
potential. For instance, 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, if the
owner will be leaving, above- or below-market owners' compensation might need
to be adjusted.
Turn to professionals
A common rule of thumb for valuing manufacturers is four to five
times earnings before interest, taxes, depreciation and amortization (EBITDA).
However, many businesses sell for more (or less) than this range. This
oversimplified formula can serve as a useful sanity check for a purchase offer.
But you shouldn't rely on it alone when selling your business. After all, it's
arguably the most important business decision you'll ever face.
For an estimate you can count on, hire an experienced business valuation pro. And contact us for support throughout the valuation process. We can help you make the most of the information you receive.
