Monthly Checklist Series


Weighing the Risks

 Business valuations help your clients--and your firm--understand an entity's strengths, weaknesses, vulnerabilities and market share in the event of its sale. In any valuation, it is important to assess financial risk--income potential vs. vulnerability to disaster. To better measure such risk, consider the following factors:

Quality of earnings

  • How profitable is the company?
  • How steady have sales and profits been over the past seven years?
  • Is the company too young (less than five years old) to determine if its earnings will be consistent?
  • Are sales flat or growing only at the rate of inflation?
  • Have sales exceeded the rate of inflation, or are they not keeping pace with it?

Type of business

  • Is the cost of entry into this industry very high?
  • Does the need for expensive fixed assets limit competition?
  • Is it a service business with few securable fixed assets?
  • Are inventory and equipment a large part of the company's total value?
  • Does the business depend on the health of other industries over which it has no control?
  • How long has the company been in business?

Prospects for the future

  • What is the outlook for the industry as a whole?
  • Does the company provide ordinary products in a field with little growth?
  • Is it likely the company's products and processes will soon be outmoded?
  • Does the company possess up-to-date technology and a well-developed research and development program?
  • Is foreign competition emerging?
  • Does the company's health depend on the economy's health?

Competition

  • How competitive is the market for the company's products or services?
  • What is the company's standing vis-a-vis the competition?
  • Is there a low cost of entry that encourages new competition, or are there high start-up costs or proprietary products to reduce competitive threats?

Employee issues

  • Do the company's products or services require special skills, education or licensing?
  • Is the work desirable? Does it take place in a pleasant environment?

Quality of fixed assets

  • Real estate. Assess the location and desirability of facilities; the degree of obsolescence, adaptability to other uses, deferred maintenance and environmental cleanup liabilities; and the underlying land value and quality of title.
  • Machinery and equipment. Assess the degree of obsolescence and cost of deferred purchase.   Structure of the purchase transaction
  • Will any purchase of the company be highly leveraged (lots of debt)?
  • Would a buyer need to sink lots of cash equity into the deal?
  • Is the company adequately and safely capitalized?
  • How do the financial ratios compare to those of other companies in the industry?
  • Does the purchase involve a transfer of stock? What are the potential liabilities?

Other factors in assessing risk

  • Is a labor union present?
  • How strong is the staff that would remain after a sale?
  • What is the risk of competition from former staff?
  • How is the health of key personnel?
  • Is there heavy government regulation?
  • How dependable are the lending sources?
  • How healthy is the region's economy?
  • Are customer accounts diversified?
  • Are products and services diverse?
  • Is production susceptible to weather, international events or other uncontrollables? How likely is it an event affecting production will occur?

Source: Unlocking the Value of Your Business by Tom Horn. Charter Oak Press, 609 Whedbee Street, Fort Collins, Colorado, 1998. www.charteroakpress.com .

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