Owners of manufacturing businesses often wonder, “What’s my business worth?” This question is especially pressing if the business is the target of an acquisition, or if the owner is considering selling or transferring the business to heirs. Valuing your manufacturing business is a critical measure for you and your stakeholders who may include family members, shareholders, your management team, employees, and lenders.
Even if ownership changes are not imminent, knowing the value of your manufacturing company is an important metric to help you make business decisions and plan effectively for whatever may come: an unexpected business interruption, an unsolicited offer to buy, or taking the next step in your exit plan.
Ways to Define Your Company’s Value
Business valuation determines the economic worth of your manufacturing company. There are three common methods used to define the value of a business:
1. Fair market value is the theoretical price that a willing buyer would pay to a willing seller. It is a price independent of any related party interests and without any known outside influence.
2. Investment value considers the value of your company based on a specific buyer’s investment expectations or requirements. The buyer may have a defined strategy or purpose for buying the company that could impact the price they are willing to pay for the business.
3. Liquidation value is the value of your company if assets were sold off and liabilities were settled in an orderly fashion. It operates under the assumption that the assets of the business are worth more when sold piecemeal rather than as an operating entity.
The Importance of Net Working Capital
Net working capital is the “grease” that keeps your business running. A manufacturing company’s net working capital is critical to any type of valuation because it allows the business to continue operating from the first day of new ownership. The components of net working capital include accounts receivable that provide for future cash flow, on-hand inventory to execute sales orders, and other current assets, less current liabilities. If a business has inadequate working capital, the business can suffer because it may be unable to pay its bills in a timely manner, and a potential buyer may insist on a commensurate decrease in the offering price for the business. If a business has excess working capital, the owners can take cash distributions without effecting the operations of the business. If a company has excess working capital, that amount will be added to the fair market value of the company.
All stakeholders and buyers will be interested in the net working capital of the business. You should monitor net working capital as part of your month-end or quarter-end financial review process so that you have an ongoing picture of the value of your business by analyzing the balance sheet, income statement, and cash flow information.
Four Ways to Approach Valuation
Valuation experts generally use one of four approaches to value manufacturing businesses. These are:
1. The discounted cash flow (DCF) approach is often the preferred method because the valuation is based on estimated future operating results of the company, rather than historical results. DCF does not rely on comparisons to other companies. The valuation is based on a number of assumptions such as projected revenues, industry growth, and discount rates. DCF places less emphasis on the balance sheet and more emphasis on earnings, where the valuation can be based on the buyer’s required rate of return combined with the growth potential of the business.
2. Comparable transaction analysis is an “apples-to-apples” approach where a general valuation is determined based on recent transactions involving similar companies in similar industries. It involves conducting research on recently sold similar companies and applying the transaction data to the manufacturing business under valuation. It is rare, however, to be able to identify companies that truly are apples-to-apples, so the precision of a “comp” valuation might not be very tight. However, attributes of comparable transactions can be informative and help build a case for your transaction.
3. Asset-based valuation focuses on the net asset value of a company. It uses a balance sheet approach, subtracting the liabilities from the assets to arrive at a number that can support the fair market valuation of the company. Valuation adjustments are made to adjust assets and liabilities to their fair market values. For example, property and equipment that has been depreciated, and inventory that may be under or over-valued would be adjusted to values a willing buyer and willing seller would accept.
4. The industry rules of thumb approach is a “back of the napkin” method of valuation in which a multiple, usually based on industry standards is applied to adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) to arrive at the value of the company. This market-based approach can usually be prepared quickly and may provide a general assumption for a valuation range, but it does not account for specific qualitative information about the business under valuation. A rule of thumb approach should only be used in conjunction with other methods.
The first step in determining the value of your manufacturing business is to perform a valuation analysis. You can do so internally or work with an external advisor such as a your CPA . A valuation analysis will provide a clear picture of where your company stands and improve your understanding of its strengths and challenges. With a base valuation in hand, you can define your value gap, which is the difference between your company’s current valuation and the valuation you would like to reach. This will help you more effectively set goals and objectives for your business so that you can best plan for a transition or successful exit strategy.
MichaelSilver has an experienced, fully accredited, and trusted valuation team that can answer any questions or prepare a valuation of your company. Please contact our Valuation Services Group at 847.982.0333.