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Articles From Brisbane Consulting Group

Know the Company’s Value Before Meeting with Lenders

An understanding of a company’s value is critical when applying for new loans to grow the business or renegotiating existing terms to be more favorable. Balance sheets give financial statement readers insight into a company’s financial position — specifically its assets and liabilities — at a given point in time.

However, it can be dangerous to equate the book value of equity on the balance sheet with the company’s fair market value. This is because current market values are based on future earnings and the prices paid for comparable companies. Thus, a balance sheet can present an incomplete picture of financial position.

Book Value vs. Fair Market Value

The balance sheet is a logical starting place for lenders when approving loans. And valuation professionals use it when applying the cost (or asset-based) approach to value a business. But it’s important to recognize ways book value can differ from fair market value.

For example, intangible assets — brand names, patents, customer lists, goodwill and so on — are usually omitted from the balance sheet, unless acquired from a third party. Contingent liabilities also may be excluded.

Additionally, under U.S. Generally Accepted Accounting Principles, assets are reported at the lower of cost or market value. So, a building acquired 50 years ago might be worth far more than the balance sheet reflects.

Accelerated depreciation methods also tend to underestimate the value of property, plant and equipment. For instance, a fully depreciated tool, which has no value on the balance sheet, may continue to be used in daily operations.

Likewise, accounts receivable can include stale, uncollectible invoices, and some inventory items might be obsolete, missing or damaged. These anomalies are especially likely if the company’s financial statements aren’t audited.

It’s noteworthy to compare net book value with the valuator’s conclusion. Pinpointing the sources of discrepancies between these two values helps lenders understand what’s driving value and what’s missing on the financial statements.

Future Earnings

Under the market and income approaches, a company’s value is a function of its future earnings. Many factors inside and outside the business can alter future expectations.

Valuators evaluate a company’s historical financial statements to determine trends. In addition to management’s business plan and financial projections, industry research can help ascertain whether historical trends are likely to continue. For example, new technology or changing regulations can suddenly render a business obsolete.

Comparables

When valuation pros use the market approach to value a company, they rely on the sales of comparable businesses. Although details of private business deals aren’t publicly reported, valuators have access to private transaction databases. This data reveals the selling prices and terms of deals in the company’s industry.

Lenders often find comparable transactions particularly helpful when evaluating applications for loans to finance mergers and acquisitions. This portion of a valuator’s analysis can also help lenders understand the industry in question and how the business measures up to competitors.

In addition, write-ups about company operations, industry analysis and financial trends can be informative during the underwriting process. A valuator’s report also may disclose informal value indicators. The owners might, for instance, receive an offer to buy the business. Or they could need to estimate the company’s value on a personal loan application or draft a buy-sell agreement.

The Valuation Equation

Balance sheet adjustments, future earnings, industry trends and comparable transactions are important parts of the valuation equation. Businesses that negotiate with lenders armed with this information can usually increase their odds of getting their applications approved quickly and burnish their reputations as trustworthy loan recipients.

Know the Company’s Value Before Meeting with Lenders

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Bill is a partner with Brisbane Consulting Group Business Valuation Division, providing business valuation, forensic accounting, and litigation support services. His valuation experience includes the valuation of closely held companies, covering a wide range of industries and engagements including: marital dissolution, dissenting shareholder disputes, estates and gift tax planning, merger/acquisition, and due diligence reporting.

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