Retirement. Loan applications. Shareholder buyouts. Divorce. Understanding what improvements drive the most value. There are many reasons to value your business. But, manufacturers cannot necessarily find the answer on the face of their balance sheet — or rely on industry rules of thumb. Instead, you will need to hire a business valuation professional to get a reliable estimate.
Valuators bring value
If you Google “valuation rules of thumb for manufacturers,” a wide range of results will appear. A common valuation rule of thumb 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 the buyer, the industry and the performance of the company.
This oversimplified formula can serve as a useful sanity check for a purchase offer. However, you should not rely on it alone when selling your business, because it is arguably the most important business decision you will ever face.
Tangible assets — such as receivables, inventory and equipment — are important to manufacturers. However, in a technology-driven, relationship-based market, intangibles — such as customer lists, patents, assembled workforce and goodwill — also contribute significant value. Professional valuators generally look beyond the cost approach and, instead, rely on market or income-based methods when valuing businesses in the manufacturing sector.
Let the market decide
Under the market approach, sales of comparable public stocks or private companies may be used to value your business. Finding comparables can be tricky, 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, it is 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 non-cash terms and future payouts, such as earn-outs or installment payments.
Cash is king
Under the 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, such as below-market owners’ compensation or non-essential travel expenses. This is almost always the case when working with privately owned companies. (See “How Valuators Adjust a Financial Picture.”)
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.
How much is your business worth today? You probably have a rough estimate in your head, but most owners have limited experience in the M&A market. A valuation professional can provide an objective answer that you can take to the bank ― or a courtroom and beyond. Even more important is using a current valuation to identify what changes you should make in order to increase value for the time when you are ready to sell.
Sidebar: How valuators adjust a financial picture
Oftentimes, professional valuators tweak financial statements before using them to appraise a business. Three common types of adjustments are:
These align the company’s financial statements with GAAP or industry standards. For example, if the company uses the cash (versus the accrual) accounting method, balance sheet items might be adjusted.
- Non-Recurring and Non-Operating Items
Historical financial results are not as relevant to investors as future potential. Valuators might eliminate discontinued operations and one-time events unless they are expected to recur.
- Discretionary Spending
These adjustments are not appropriate for all businesses. For instance, above- or below-market owners’ compensation may be adjusted — but only if the owner will be leaving.