Valuation Methodology

There are various valuation methodologies and approaches.

An earnings multiple based valuation is calculated in two stages; the first stage is to arrive at the Enterprise Value and the second stage is to arrive at the Equity Value.

Enterprise Value is the value of the business on a cash and debt free basis and is calculated by applying a multiple to the future maintainable profit of the business.
The profit multiple applied can differ according to the size, nature and stage of life a business is in. However, there are numerous Financial, Commercial, Operational, Corporate and Legal actions a business owner can take to enhance value.
Future maintainable profit is a financial measure used to illustrate the operational profitability of a business and is usually based on current and future financial performance. It is calculated by making numerous adjustments to reported profits for non-commercial, non-market rate and non-recurring income and expenditure and is usually presented as either EBITDA or EBIT which are considered to be a neutral measure of profitability as interest costs, taxation and accounting estimates (that can differ under alternative ownership) are excluded.

Equity Value is the value of the shares and is calculated by adding (or deducting) net cash (or net debt) to the Enterprise Value and is further adjusted upwards (or downwards) for every £ working capital in the business exceeds (or falls below) the normal level of working capital.
Net cash (or net debt) is calculated by netting off any cash, cash equivalents, debt and debt like items in the business that are part of the day-to-day net working capital.
The normal level of working capital is calculated by reviewing the current and historic debtor, creditor and inventory levels of the business

Profitability

The historic, current and future financial performance of a business are a crucial part of a potential buyer’s investigations and the more a business can demonstrate a strong track record of growth and maximising profitability the more confidence a potential buyer will have in maintaining this going forward and paying a higher multiple.

For a business preparing for sale, the following actions can be taken to enhance the value of the business:

Reconciliations: Clear reconciliations between management information and statutory information should be recorded.

Financial analysis: Make all key financial information easily identifiable and appropriately categorised to ensure suitable analysis can be undertaken such as identifying turnover by customer, location, product or employee costs by department and location. The use of cost centres and profit centres are also an effective way of recording the performance of different segments of the business.

Margins: Profit margins are a key performance indicator for all businesses and often used to benchmark against other businesses in the industry or sector. It is important to ensure actions are taken to maintain and grow margins and that they are monitored internally.

Trends: Business performance data should be continually monitored, and the use of charts and graphs are an effective way for users to visualise the positive and negative trends in the business to assist with decision making.

Turnover and volumes: Clearly identify revenue streams, the nature of the revenue, recurring revenue and the relationship between volumes and value. Focus on maintaining and growing levels of turnover and volume.

Cost reductions: A periodical assessment of costs should be undertaken to identify areas where the business can reduce costs and improve performance such as switching service providers and taking advantage of bulk discounts. Budgets should also be set to ensure performance is monitored and actions are taken.

Normalising profits: Identify and document all income and costs within the business that are not on an arm’s length basis and need adjusting or would not be incurred under alternative ownership such as wives’ and children’s salary costs. Build a supporting case to reduce challenges and avoid any doubt around the level of normalised profits that are being achieved by the business.

Working Capital

Working capital is an often-overlooked source of value and can be difficult for owners to firmly grasp. Working capital is the lifeblood of a business and potential buyers will expect to receive a normal level. Effective working capital management is therefore vital for understanding the true day to day needs of the business and if managed correctly, it can free up trapped cash and lower the level of working capital a buyer expects to be delivered.
Working capital = Trade Debtors + Inventory – Trade Creditors
For a business preparing for sale, the following actions can be taken to enhance the value of the business:

Credit periods: The period in which debtors are received and creditors are paid should be controlled. Take steps to reduce the time taken to receive payment from customers and stretch the period creditors are paid (within reason). A periodical assessment of credit terms can be a useful exercise to identify areas for improvement and to ensure terms are competitive.
Stock control: Effective stock control measures should be taken to reduce the level of stock held to be at an optimum level. An excessive stock holding is a cash burden on the business whereas an insufficient stockholding can damage the reputation of a business when sales cannot be delivered in a timely manner. Steps taken to control stock include periodical stock counts, robust policies and management systems, clear interdepartmental communication, forward planning and reducing waste.
Working capital days: Debtor, Stock and Creditor days are a key financial performance indicator to assist with the analysis of working capital.
Trends: The use of graphs to plot out the periodic levels of working capital is an effective way to visualise the trends and to assist with identifying anomalies, seasonality and exceptional items to understand a true normal level of working capital at a particular point in time.

Cash and Debt

The level of cash and debt in a business at the point of sale will determine the value that a business owner receives at completion. Actions should be taken to maximise the level of cash that is considered surplus to requirement (i.e. not needed to fund the normal level of working capital or to invest in infrastructure) and to reduce the level of debt without putting the business under undue financial strain prior to a sale

Cash	Debt
Cash at Bank Loans Receivable Corporation Tax Receivable	Loans Payable Hire Purchase Invoice / Stock Finance Corporation Tax Payable

For a business preparing for sale, the following actions can be taken to enhance the value of the business:
Cash flow: Monitoring the cash flow of the business and understanding where cash is being generated and extracted is crucial for effective cash management and decision making. The business should maintain a cash flow statement to record the historic and project the future operational, financing and investing activities of the business.
Financial measures: The use of financial measures such as CFADS (Cash Available for Debt Service) can be an effective tool for understanding the headroom a business has to repay and service the levels of debt in the business and to take reasonable steps to reduce the level of debt.
Policies: Clear and concise policies should be established for the payment of dividends, reinvestment in plant and machinery and acquisition reserves to clearly demonstrate the free cash available in the business

Financial Projections

To most buyers you will be selling the future financial performance of the business and the cash flows it will generate. For any successful business, having a robust financial projection is a critical part of business operations to ensure the business has suitable resources in place and can navigate through difficult obstacles.
For a business preparing for sale, the following actions can be taken to enhance the value of the business:
Actuals v budgets: Maintaining a record of the historic track record of actual financial performance v budgeted performance can be a valuable tool for supporting financial projections. Variance analysis can also be performed to reinforce the accuracy of budgets.
Integrated forecasts: Financial projections should integrate the profit and loss, balance sheet and cash flow statement to provide a comprehensive picture of the projected business’s financial position at a point in time with clear assumptions, supporting documentation and polices included to support the case.
Credibility: Financial projections need to be reasonable, believable and achievable to further demonstrate the value of the business to a potential buyer. It needs to be tailored to the business with specific and current data and information.
Up to date: The financial projections should be continually updated as and when new information is available. When actual information is published this should overwrite the projected information.