Many manufacturer owners may have a ballpark idea of their company’s value. But a professional valuation is essential if you’re considering selling your manufacturing business. You also may need one if you’re applying for a loan, seeking other financing, drafting a buy-sell agreement or estate planning. A professional valuation can even be useful in strategic business planning.
Why you shouldn’t rely only on informal value indicators
If you search online for “valuation rules of thumb for manufacturers,” a wide range of results will appear. A common value formula for manufacturers is four to five times earnings before interest, taxes, depreciation and amortization (EBITDA). But many businesses sell for more (or less) than this range, depending on market conditions and business-specific characteristics (such as management quality, financial performance and internal risk factors).
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, arguably the most important business decision you’ll ever face. You need to work with a valuation professional who has the experience and expertise to provide an objective value estimate for your specific company, based on relevant market and economic factors.
Looking beyond your hard assets
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. So, professional valuators generally look beyond the cost approach and instead 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 tend to be conglomerates, making meaningful public stock comparisons difficult.
When researching transaction databases, valuation professionals filter deals using relevant criteria, such as the industrial classification code, 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.
Factoring in possible adjustments
Sometimes professional valuators tweak financial statements before using them to appraise a business interest, such as by:
Normalizing. Valuators may align the company’s financial statements with 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.
Eliminating 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.
Adjusting discretionary spending. If the owner will be leaving, above- or below-market owners’ compensation might need to be adjusted.
Turn to the professionals
The process of valuing a manufacturing company is hardly simple. And using only your balance sheet or industry rules of thumb won’t give you enough information to make well-informed business decisions. Turning to a professional valuator with thorough knowledge and experience in the manufacturing sector is the smart move. We can also provide helpful support.
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