Do you know the current value of your business? Even if you’re not considering selling your company or otherwise transferring its ownership right now, it could happen sooner than you think.

In some cases, an ownership transfer becomes suddenly appealing when a company struggles to the extent that a sale becomes the best avenue for starting over. But more positive circumstances can drive the decision, too. For example, a small to midsize business might do so well that it receives an acquisition offer that’s too good to pass up.

Whether it’s an impending ownership transfer, or just a need to learn more about your company, it’s important to establish reasonable expect

Answering the Right Questions

Some owners mistakenly believe that the balance sheet tells how much a company is worth. But most businesses possess goodwill and other intangible assets — as well as unreported liabilities — that don’t show up on the financial statements.

In truth, cost-based valuation metrics aren’t often used in real-world transactions. Instead, the most popular methods for valuing private businesses include the discounted cash earnings, guideline company transactions and capitalization of earnings techniques. Calculating value under these methods requires the expertise of an outside valuation professional.

To better understand the valuation process, answer these basic questions:

What’s the purpose? It could be as clear-cut as an impending sale. Or perhaps a divorce is on the horizon, and the owner must determine the value of the business interest that’s includable in the marital estate. In other cases, the valuation may be driven by tax, estate or strategic planning.

What’s the appropriate standard of value? Generally, business valuations estimate “fair market value” — the price at which property would change hands in a hypothetical transaction involving informed buyers and sellers not under duress to buy or sell. But some assignments call for a different standard of value.

For instance, say you’re contemplating selling to a competitor. In this case, you might be best off determining the “strategic value” of your company — that is, the value to a particular investor, including buyer specific synergies.

What’s the appropriate basis of value? There’s a hierarchy of different types of value based on the degree of control and marketability an interest carries. Investors place premiums on the abilities to 1) control business decisions and 2) sell the interest on the “market” as quickly and inexpensively as possible.

Digging Deeper

Defining the appropriate basis of value in a business valuation isn’t always straightforward. Suppose a business is split equally between two partners. Even though each owner has some control, stalemates could impair decision making.

On the other hand, a 2% owner might possess some elements of control if the remaining shares are divvied up equally between two 49% owners. Definitively establishing the basis of value requires careful consideration of who owns the rest of the business — and how that allocation affects value given applicable state laws and ownership agreements.

Getting it Done Right

Regular valuations can be an important management tool — particularly if you plan to sell or transfer your interest anytime soon. We can explain the valuation process to you further and have the expertise to help you. Contact our senior manager, Jessica Kinney, CPA, CVA, CFE today to talk about how we can help you with your valuations.

The income statement can be an intimidating financial statement to comprehend and analyze for those not familiar with the intricacies of accounting rules, but grasping two basic principles isn’t that difficult.

Principle 1: That number at the bottom – there’s a reason they call it the “bottom line” – needs to be a positive one.

Principle 2: There’s only one way to ensure that number is positive – take in more money than is going out.

So to nudge the calculation toward a positive outcome, businesses need to increase revenue or lower expenses, and preferably both.

Increasing revenue is the never ending task of a business’s sales and marketing functions, and it’s a rare day that owners and managers aren’t thinking about ways to increase the top line.

Cost containment tends to get less attention. It’s the less glamorous part of running a business. It’s easy to overlook.

And even when expense management gets the necessary attention, there are significant constraints on how much it can contribute to improving the bottom line. There’s no ceiling, theoretically, to the sales number. The expenses number, however, can only go to zero, never mind whether you can actually run a business while spending no money.

But businesses that want to be successful, or remain that way, may find that 2019 is the Year of Cost Containment.

Shouldn’t that be every day, week, month and year? Well, yes, but a year in which numerous threats of increased expenses are percolating, and in an environment of low growth, thin margins and a bruising competitive landscape is a year to be particularly vigilant on costs.

What sort of costs? Since we’re talking about money, let’s talk about the cost of money – interest rates. The Fed spent the last decade and a half driving interest rates down to effectively zero, and kept them there, in a succession of efforts to keep the economy from flat lining. That was terrible for savers, great for borrowers (providing they could actually access credit).

The Fed’s thinking has shifted to believing the economy has sufficiently recovered strength and growth that the biggest concern is now the potential for a revival of inflation. Agree or not with the Fed’s reasoning, the trend line is unmistakable. The Fed posted three quarter-point hikes in 2017.

Whatever the number, the cost of lines of credit and other forms of borrowing will go up next year.

Not many things went manufacturing’s way last decade, but one thing that did was the cost of energy. With the huge expansion of U.S. production of both oil and natural gas, supplies became plentiful and prices were driven down. Manufacturers benefitted four ways: cheaper feedstocks, cheaper parts and products made from oil and gas, less expensive fuel for industrial heating and less expensive electricity (natural gas in particular is widely used as a generating fuel).

The bad news is that prices for both oil and gas are off the bottom of the trough and can be expected to rise. The good news is that supply is still plentiful, blunting the potential for sharp price spikes and dampening long-term inflation in energy costs.

An increasingly large line item on the expense portion of the income statement is the cost of various governmental laws, regulations and mandates. The recent spate of increases, imposed and proposed, in Seattle (the income tax), the Puget Sound region (Sound Transit) and the state of Washington (family leave, a carbon tax) is likely to continue unabated, given the region’s political climate.

Health care? Manufacturers have been scrambling for years looking for some options to hold increases to a dull roar, never mind actually reducing them. Don’t expect much moderation in that benefit.

New technology isn’t something that people think of as an expense, but rather as an asset. But manufacturers are facing pressure to keep up with the latest innovations – 3D printing, the industrial Internet of Things – and those won’t be cheap. The resources to pay for those assets will have to come from other asset classes, like cash reserves, or they’ll have to be financed. Either way, it’ll run to money.

That’s a lot of increased expense, and it’s hardly an exhaustive list. In tight labor markets like the Puget Sound region, where workers find housing and the cost of commuting getting ever more expensive, the pressure on wages sufficient to recruit and retain employees will be upward.

It’s the number of potential increases, not just the size in any one category, that makes the need for cost containment so vital in 2019. The increases may be individually small, but they add up fast, and they threaten to gnaw away at margins.

Adding to the pressure to do something about costs: customers leaning on suppliers and vendors to trim their prices. Manufacturers in the aerospace supply chain know all too well of Boeing’s campaign to cut supplier costs. Boeing has its own pricing issues to worry about in the continuing competition from Airbus, Bombardier, China and other foreign passenger-jet developers, and it has made plenty of public noises about getting back into parts production if it believes it can do so for less than what it’s presently paying outside suppliers. The competitive pressure on Boeing isn’t likely to relent in 2019, so neither is the pressure on aerospace suppliers. And while Boeing is the most visible of original equipment manufacturers leaning on suppliers (who in turn lean on theirs), it’s hardly alone.

As much time and effort as manufacturing executives and managers are already expending on cost containment, 2019 will see the urgency ratcheted up further. As much as they believe they looked internally and externally, as many of the obvious fixes and cuts as they’ve made, in 2019 those measures and their results are likely to be greeted with the message of “Great! Now do some more.”

By Bill Virgin
Bill Virgin is editor and publisher of Washington Manufacturing Alert and Pacific Northwest Rail News. He is a longtime business writer in the Northwest, currently producing stories and columns for such publications as The News Tribune in Tacoma and Seattle Business magazine. He and his wife also own Page 2 Books in Burien.

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