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Questions
& Answers
What
affect do items on the balance sheet have on my valuation if
I use a multiple of earnings method
The
Question
Our
business has left a good deal of cash in the business. It is
a trades/service/construction business which does about $8M
gross.
The
retained earnings in the business is about $2.5M, in the form
of cash, inventory, vehicles, and receivables. From what I have
seen this is an above average amount of cash in a business.
When pricing the business how is this asset factored in to the
valuation?
Aside
from valuing the business on a multiple of EBIT, how does the
balance sheet affect the price?
The
Answer
Some
of the items on the balance sheet such as machinery, vehicles
and equipment are required in order for the business to produce
its earnings. So the value of those assets is already reflected
in the EBIT you are multiplying.
The
cash and receivables are usually kept by the owner after the
sale so they wouldn’t affect the price. If the buyer is going
to take over the receiveables than you and the buyer will have
to agree on a fair value for them in addition to the EBIT X
multiple number. The EBIT X a multiple calculation is a way
of placing a value on the future earnings of the business that
the buyer will benefit from. Your receiveables represent money
you have already earned so the buyer would have to pay extra
for them. Exactly what your receiveables are worth today and
just how collectible each account is may be something you and
the buyer don’t agree on. That’s why it’s simpler for the seller
to just retain the receiveables. Whatever the factors are that
have allowed you to retain so much extra cash - higher profit
margins, lots of repeat customers, an exceptional staff of employees
- would affect the valuation in that you can justify a higher
multiple.
In most
cases, the inventory is valued at its replacement cost. Not
at what the seller paid for it or what it can be retailed for,
but what it would cost the new owner to go out and replace the
inventory.
