Business valuation is a prophecy of the future. That is, investors typically value a business based on its ability to generate future cash flow. 然而, with so many uncertainties in the current marketplace, forecasting expected cash flow can be challenging.
Income Approach
Under the income approach, the value of a business interest is a function of two variables:
1. Expected economic benefits.
2. A discount rate based on the risk of the business.
Economic benefits can take many forms, such as earnings before tax, cash flow available to equity investors 和 cash flow available to equity 和 debt investors. Likewise, discount rates can take many forms. Examples include the cost of equity or the weighted average cost of capital (加权平均).
Common valuation methods fall under the income approach include:
Capitalization of earnings. Under this method, economic benefits for a representative 单 period are converted to present value through division by a capitalization rate. The cap rate equals the discount rate minus a long-term sustainable growth rate. This technique — sometimes referred to as the capitalized cash flow (CCF) method — is generally most appropriate for mature businesses with predictable earnings 和 consistent capital structures. It’s also commonly used to value real estate with a predictable stream of net operating income.
Discounted cash flow (DCF). This method derives value by discounting a series of expected cash flows. The “cash flow” at the end of the forecast period is known as the terminal (or residual) value. Terminal value is typically calculated using the market approach or the capitalization of earnings method. It represents how much the company could be sold for at the end of the forecast period, when the company’s operations have, 在理论上, 稳定.
DCF models are generally more flexible than the capitalization of earnings method. 例如, the DCF method is well suited for high growth companies 和 those that expect to alter their capital structure over the short run.
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Adjusting for 新型冠状病毒肺炎 Impact
During the p和emic, many valuation professionals are using DCF models, rather than the capitalization of earnings method, to better capture temporary changes in the marketplace. The appropriate time frame for a DCF analysis depends on how long the subject company expects its operations to be disrupted. Some experts currently use two- or three-year DCF models; others prefer to use a longer time frame.
除了, it’s important for valuators not to double-count 新型冠状病毒肺炎-related risk factors in both the company’s expected economic benefits 和 the discount rate. Many valuation professionals are reportedly capturing the p和emic’s impact in forecasts, rather than building it into their discount rates.
Evaluating Inputs
A business valuation is only as reliable as the inputs on which it’s based. Business valuation professionals typically rely on 管理 to prepare forecasts. But, in the 新型冠状病毒肺炎 era, those estimates may necessarily not be reliable. That’s because managers tend to use the prior year’s results as the starting point for forecasting the current year. Then it’s assumed that revenue, variable expenses 和 working capital will grow at a moderate rate, while fixed expenses will largely remain constant.
然而, these simplistic models may no longer be valid in today’s volatile, evolving marketplace. Many businesses — including resorts 和 casinos, sports venues, schools 和 movie theaters — have temporarily shut down or scaled back operations during the p和emic. Others are using new methods of distribution or devising pivot strategies to stay afloat. Examples include doctors 和 therapists who are providing telehealth services, restaurants 和 retailers that are offering online ordering, delivery 和 curbside pick-up, 和 food processing facilities that are selling directly to consumers rather than to cruise lines 和 high-end restaurants.
除了, cost structures have changed for many types of businesses. 例如, most white-collar workers are working from home instead of commuting to offices, people of all ages are converting from in-person to online learning, companies are eliminating nonessential travel, 和 some organizations have become increasingly reluctant to work with overseas suppliers. 除了, in the face of a contentious, divisive presidential election, there’s significant uncertainty about the future of federal tax laws 和 other government regulations.
Which changes will be temporary, 和 which will last beyond the 新型冠状病毒肺炎 危机? No one has a crystal ball, but it’s likely that some changes — including work-from-home arrangements 和 other cost-cutting measures — will be part of the new normal. Other aspects of the everyday life — such as attending sporting events, going on vacations 和 dining out — are expected to eventually return to normal. But it’s still unclear how long recovery will take.
So, before discounting expected earnings, it’s important to evaluate whether 管理’s forecasts seem reasonable. Oversimplified models 和 unrealistic assumptions can lead to valuation errors.
Outside Expertise
Estimating how much cash flow a business will generate is no easy task in today’s unprecedented conditions. A trained valuation professional is atop the latest trends 和 economic predictions. He or she can help 管理 create comprehensive forecasts that are supported by market evidence, rather than gut instinct 和 oversimplified assumptions. 联系 your valuation professional for more information.
Reach out to us for assistance with your business valuation:
Councilor, Buchanan & Mitchell (老葡京手机app) is a professional services firm delivering tax, accounting 和 business advisory expertise throughout the Mid-Atlantic region from offices in 马里兰州贝塞斯达 和 Washington, DC.
