How to Value Your Manufacturing Business
By Greg Pasiadis, Manager, Accounting Services
The value of your manufacturing business is a critical measure for you and the various stakeholders who have an interest in your business. Stakeholders can include your family, shareholders, employees, and lenders, among others.
The valuation of your company might be viewed as the most important metric for potential acquirers, next generation heirs, or in the event of a planned or potential transition, members of your senior management team. Understanding the value of your business will help you make future decisions and will prepare you for the next step in your exit plan, an unexpected business interruption, or even an unsolicited offer to buy.
Before discussing how to value your manufacturing business, let’s first define the three basic definitions of value: fair market value, investment value, and liquidation value. Fair market value is a hypothetical price that a willing buyer would agree upon with a willing seller. It is a price for your manufacturing business without any related party interests at the table, so the sales process occurs without any known outside influence. Investment value represents the value of your company based on a specific individual’s investment requirements or expectations. The investor could have a defined purpose or strategy for buying the company, which would impact the valuation. Liquidation value is the value of your business under the assumption that the business is worth more as a dormant concern than as an operating entity. In other words, the business owner would sell the company’s assets piecemeal versus as a whole.
Four Valuation Approaches
So how do we value your manufacturing business? Among the various valuation approaches practiced, the four most popular are: asset-based valuation, industry rules of thumb, comparable transaction analysis, and discounted cash flow.
- Asset-based valuation is a balance sheet-driven approach, netting the assets and liabilities to arrive at “the rest,” which can support a factor to the fair market valuation of the company. Valuation adjustments would occur from book value to fair market value, including measuring property and equipment or inventory that has been depreciated (reduced in value) at a value a willing buyer and willing seller would agree upon.
- The industry rules of thumb approach is the “back of the napkin” indication of value, where a multiple is expected by industry and applied to adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) in order to arrive at an enterprise value. This market-based approach is usually the quick answer and a general assumption for a valuation range, but does not account for specific qualitative information about the business under valuation.
- Comparable transaction analysis involves research on similar and recently sold companies and applying the data to the business under valuation, also based on the market. This is the apples-to-apples approach, where a general valuation is determined based on another recent transaction involving a similar company in a similar industry. However, rarely can we identify companies as truly apples-to-apples, so the precision of a “comp” valuation might not be as reliable. Attributes of comparable transactions could be informative, however, and help build a case for your transaction.
- The discounted cash flow (DCF) approach is often preferred because the valuation is based on estimated future operating results of the company, rather than historical results. Also, the valuation does not rely on comparisons to other companies. The estimates include assumptions such as projected revenues, industry growth, and discount rates. DCF will have less of an emphasis on the balance sheet and more of an emphasis on earnings, where the multiple can be based on the buyer’s required rate of return, combined with the business’s growth potential.
Net Working Capital
Net working capital is very important for all types of valuations in manufacturing. The net working capital allows the business to continue functioning on Day One of new ownership. Your business needs accounts receivable for future cash flow. It needs inventory on hand to execute on sales orders, and it needs the property, plant, and equipment to operate and turn said inventory into a salable product. All stakeholders will be interested in the net working capital of the business at a given time.
Going forward, ensure that as part of your month-end or quarter-end financial review process, your manufacturing company is assessing the value of the business, as opposed to just the balance sheet, income statement, and cash flows.
If you have not performed a valuation analysis internally or worked with an external advisor, such as a financial planner, CPA, or exit planning advisor, we highly encourage you to do so. The valuation analysis will provide a definitive understanding of where the company stands, enabling you to better set goals and objectives. Once your base valuation is determined, you can better define your value gap, or the difference between the current valuation and the valuation you would like to reach, in order to transition or exit the business successfully.