Adapted from: Tim Miller, CLU, FALU, FLMI
(Munich American Reassurance)
Perspective on U.S. Business
In 2002 total receipts for all
U.S. firms was 22.8 trillion
dollars.
Of that amount only 770 billion
dollars was generated by
non-employer firms.
Employer firms made up about
24% of all firms and accounted
for over 96% of all receipts.
Perspective on U.S. Business
According to the U.S.
Census Bureau in 2004
there were a total of
25,409,525 businesses.
Of that number 5,885,784
were classified as employer
firms ( having a payroll ).
Firms with 100 or more
Perspective on U.S. Business
In 2004 about three quarters
of all U.S. business firms had
no payroll.
They are called non-employer
firms. There were a total of
19,523,741 firms.
They only accounted for
about 3.4 percent of business
receipts, which was over 887
billion dollars.
These firms are not included
Financial Statement Analysis
Balance Sheet
Assets
Current Assets:
• Cash and cash equivalents • Investments
• Accounts receivable net of allowance for doubtful accounts • Inventories
Long-term Assets
• Equipment
• Land and Building
Financial Statement Analysis
Other assets
• Long-term investments
• Goodwill and other intangible assets
Total Assets
Liabilities
Current Liabilities
• Notes payable • Accounts payable
• Interest ( current portion ) • Taxes payable
Long-term Liabilities
Financial Statement Analysis
• Bonds payable
• Notes payable
Total Liabilities
Stockholder’s Equity
• Common stock
• Retained earnings
Total Liabilities and Stockholder’s Equity
Financial Statement Analysis
Income Statement
Sales / Revenues
minus Cost of Sales / Revenues ( a.k.a. COGS ) =
Gross Profit
minus Operating Expenses =
Operating Income
plus/minus non-operating expenses/income =
Total Income
Minus income taxes =
Financial Statement Analysis
•Measure of ability to meet current obligations
•A ratio of 2:1 or higher is considered sufficient, a number less than 2 is suspect
Financial Statement Analysis
•The quick ratio is an indication of the ability of a company to quickly convert assets to cash to meet obligations in the event of an emergency.
Financial Statement Analysis
Debt Utilization Ratios
Financial Statement Analysis
•This ratio looks at the relationship between total assets and total debt •The amount of debt used to finance total assets.
Financial Statement Analysis
•This ratio looks at the relationship between debt and owner’s equity or stockholder’s •It is a measure of the riskiness of a company’s capital structure.
•The higher the proportion of debt the greater the risk to creditors.
Financial Statement Analysis
Times
Interest
Earned
Operating Profit
Interest Expense
•measures the ability of a company to pay interest expense associated with debt from operating profits
Financial Statement Analysis
Financial Statement Analysis
Return on Equity
•Rate of return relative to equity invested in business
Financial Statement Analysis
Operating Profit Margin
OPM
Operating
Profit
Net Sales
•Measure profit per percentage of each sales dollar
Financial Statement Analysis
Return on Assets
ROA
Net
Earnings
Total
Assets
•Also known as Return on Investment (ROI) •Indicates profitability relative to total assets
Financial Statement Analysis
Business Valuation
Business Valuation
Business Valuation
Business Valuation
Capitalization of Earnings
A valuation technique under the income approach where a
single representative period is used to determine a value for a
business through application of a capitalization rate. This
expressed as:
Value
Income
Business Valuation
Business Valuation
Capitalization of Earnings
Capitalization Rate –
Business Type / Perceived Risk
RISK
Business Valuation
Several models have been developed to classify businesses
into groups based on business characteristics with risk levels
assigned. The following model was authored by Arthur Stone
Dewing ( The Financial Policy of Corporations, 5
thEdition, The
Business Valuation
Category Capitalization Rate Multiple
Old established business with significant hard
assets and excellent goodwill
10% 10
Well- established business requiring considerable
managerial care 12.5% 8
Strong, well developed businesses susceptible to general economic swings and requiring considerable managerial care
15% 7
Highly competitive
businesses with low levels of hard assets requiring average levels of
managerial care
Business Valuation
Category Capitalization Rate Multiple
Small, highly competitive businesses requiring little capital investment
25% 4
Large or small businesses requiring special
managerial skills of one or more persons with little capital investment and in highly competitive fields where failure is a strong possibility
50% 2
Personal service businesses whose
success reflects the skill of the manager
Business Valuation
Case Sample
- Capitalization of Earnings
A sole proprietor owns a small printing operation. The business
is well established with stable earnings and a good
competitive position in the market. The company has a net
income of $100,000. This company may be considered
Business Valuation
Business Valuation
Discounted Future Earnings
RISK
RISK
Earnings Unpredictable, Highly Competitive Market, Questionable Competitive
Business Valuation
The discount rate used is reflective of the amount of risk for the particular
business in question. That is, the amount of uncertainty around realizing
the expected future earnings stream. The greater the perceived risk, the
higher the discount rate and the lower the valuation for the business.
As with the Capitalization of Earnings Method there are several models
that have been developed. One such methodology was authored by
James H. Schilt ( “ A Rational Approach to Capitalization Rates for
Discounting the Future Income Stream of Closely Held Companies,” The
Financial Planner, January 1982 ) and offers five categories with
Business Valuation
Category Discount Rate
#1 – Established businesses, good trade position, good management, stable past
earnings, predictable future 6 – 10%
#2 – Same as #1 except in more
competitive industries 11 – 15%
#3 – Companies in highly competitive industries, with little capital investment and no management depth, although with good historical earnings record
16 – 20%
#4 – Small businesses that depend on the skill of one or two people, or large companies in highly cyclical industries
with very low predictability 21 – 15%
#5 – Small personal service businesses
Business Valuation
Year Cash Flow Discount Factor
10% Present Value
1 $100,000 0.9091 $90,910
2 $103,000 0.8264 $85,119
3 $106,090 0.7513 $79,705
4 $109,270 0.6830 $74,631
5 $112,550 0.6209 $69,882
6 $115,930 0.5645 $65,442
7 $119,410 0.5132 $61,281
8 $122,990 0.4665 $57,333
9 $126,680 0.4241 $53,725
10 $130,480 0.3855 $50,300
Business Valuation
In this
example
we have a company with projected revenues of
$1,146,400 over the next 10 years. Using a discount rate of
10% applied to each of the ten years a total figure of
$688,328 is calculated. This is amount represents the value of
that revenue stream today to a potential buyer given the
assumptions made. A business with a perceived higher risk
would be given a higher discount rate and the value
Business Valuation
Business Valuation
Valuing Professional Practices
Business Valuation
Goodwill
Business Valuation
Factors Affecting Value
Business Valuation
Cash Basis Accounting
In professional practices cash-basis accounting is often used.
This may make some financial statement adjustments
Historical Perspective on Valuation
Based on historical prices for businesses sold, it was noted the multiple of
owner’s discretionary income ( ODI ) increased with the amount of ODI.
ODI Multiple
< $100,000 1.2 – 2.4
$100,000 to $250,000 2.0 – 3.2
>$250,000 to $500,000 2.5 – 3.6
>$500,000 to $1,000,000 2.5 – 4.2
Over $1,000,000 EBITDA was
used 3.5 – 5.5
$2,000,000 5 +
