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Top Metrics for Business Valuation

If you were looking to purchase a business, what would be your top 3-5 metrics you would review from the companies financials to make your decision?

Answers

EMERSON GALFO
Title: CFO
Company: C-Suite Services
LinkedIn Profile
(CFO, C-Suite Services) |

First off, I would NOT base my decision solely or primarily on financials and metrics. Aside from the fact that financial statements can be "manipulated", it is only a snapshot in time and backwards looking.

Here are SOME intangibles that I look for: Note that the things I am looking for are all forward looking.

1. Sales/Revenue - Quality of clients, term of contracts, probability of holding on to the clients, continuing the revenue trend or being able to hit the forecasts.
2. Processes (All) - are there ways that I can improve on the current process to shave off cost.
3. Personnel - quality of personnel, probability that personnel will stay and not bail.

This is the principle that I follow and this may be a different view from most.......

It is not the quality (financial statements) or even the amount of the purchase but what you can do with the company relative to the price.

Larry Signorelli
Title: CFO
Company: The Vane Brothers Companies
(CFO, The Vane Brothers Companies) |

I agree with Emerson. As a long-time M&A director/advisor for public and private companies before becoming a CFO, you can overpay some for a good company/fit and it can still be a good deal. You can steal a bad company/fit and it will usually still be a bad deal.

Anonymous
(CFO) |

Emerson,
I can appreciate your comments and I would agree. Curious if you have access to tax returns, financials, basically open book; if there would be anything specific you would look for. I completely agree and have witnessed falsified data many times.

EMERSON GALFO
Title: CFO
Company: C-Suite Services
LinkedIn Profile
(CFO, C-Suite Services) |

Anon,

Open book is the only way. I will not touch a company that won't do open book. However, as I said, I have NOT based my decision solely or primarily on the financials. Massaged, manipulated financials is just one reason. But what I enumerated are more important to me than the financials as far as whether to buy it or not. The most the financials can help with is price determination/negotiation.

Anonymous
(Director ) |
Topic Expert
Dana Price
Title: Vice President, M&A
Company: McGraw Hill Education
(Vice President, M&A, McGraw Hill Education) |

Following on Emerson's comment about the entire look and checking out all the financial related items, if you are asking about metrics, it really depends upon the type of business. Things like # of customers/subscribers/licenses/seats/units, # of products, customer rankings (the 80/20 rule), inventory turns, new products, pricing, # of ads, cash conversion, operating FCF, DSO, new vs. renewal, square footage/booths sold, gross vs. net revenue just to name a few that come to mind.

Topic Expert
Wayne Spivak
Title: President & CFO
Company: SBAConsulting.com
LinkedIn Profile
(President & CFO, SBAConsulting.com) |

I would add to Dana's list % of sales used for advertising last several years. This has an impact on future business.

Let's not forget the interviews with employees, customers, vendors, management, market research etc. M&A is more as everyone has stated the sum of the numbers, it's both objective and subjective quality of both numbers and people and brand.

David Rau
Title: CFO
Company: Cornerstoner Building Alliance Lumber SW
(CFO, Cornerstoner Building Alliance Lumber SW) |

Michael, great app. Thanks for sharing.

Michael Stimson
Title: Director
Company: GIDE International Limited
(Director , GIDE International Limited) |

You can can find the link to our free app. on EVA on our web-page.

alan dybvig
Title: Managing Partner
Company: Dybvig Consulting
(Managing Partner, Dybvig Consulting) |

I think the most important metric is the maximum profit the firm's resources are capable of generating. Given open books, this is accomplished by creating an operational activity-based income statement, not the traditional financial one, and then optimizing. Result is, by the resources available in the firm, a new maximally profitable forecast and the associated optimally feasible supply chain required to make and fulfill the new forecast.

Mark Sutherland
Title: CFO
Company: Profit By Design CFO & Controller Servic..
(CFO, Profit By Design CFO & Controller Services) |

Near the top of my list would be to look at the Cash Flow Statements over various time frames, and covering at least 2 to 3 years. At the end of the day, I'm looking to buy cash flow, or the potential for it. It's true that the P&L can be manipulated, but the CFS doesn't lie unless there is fraud in play. I'd also want to see tax returns and see how they line up with the financial reports. Return on Assets (original asset cost, not book value) is also a metric I like to use.

Gary A. Pokorn
Title: Sales Enablement Manager
Company: Oracle I NetSuite
(Sales Enablement Manager, Oracle I NetSuite) |

Valuable discussion everyone - thank you! Question from my non-Finance Professional position following up Emerson's comments about "manipulated" numbers: If the business to be purchased is running their finance and accounting functions with an outdated system; manual processes; spreadsheets; or perhaps even a "SOHO" system like QuickBooks, can this result in a discounted valuation of the company by the prospective buyer? Thx, GAP

EMERSON GALFO
Title: CFO
Company: C-Suite Services
LinkedIn Profile
(CFO, C-Suite Services) |

Gary, It may or may not....but that is a trigger for me to give more effort on my due diligence to find out the true condition of the company. Having it on QB or spreadsheets does not really affect my decision as long as my due diligence is good.

All these metric talk makes it appear that we only want to buy better run (ran?) companies. A company can have shitty (pardon) metrics but still be a good buy. Again, it is what you can do with or to the company relative to it's price is what is important. Metrics should be used to evaluate the CONDITION of the company that will affect the price. The decision to buy (at least for me) is dependent on the intangibles/other factors and what I can do with it.

When I was thinking about it, I realized that my principle (or view) has more in common with house flippers. You investigate/inspect then evaluate what you can do to the house to improve it whether as an investment of sell afterwards. The defects does NOT deter you from buying the house.

Now if you are say a retiree and have enough money to buy a business without being too involved or just let it operate without doing anything....then METRICS is your friend.

In a circular way...I hope that made sense. My views are not always "mainstream".

Mark Sutherland
Title: CFO
Company: Profit By Design CFO & Controller Servic..
(CFO, Profit By Design CFO & Controller Services) |

Gary, if there is uncertainty about the numbers you are being given by a prospective seller, that uncertainty translates to risk. So yes, you absolutely would want to discount your valuation to reflect the level of perceived risk that cannot otherwise be eliminated via due diligence. The uncertainty/risk may be so great that you have to walk away from the deal.

Michael Stimson
Title: Director
Company: GIDE International Limited
(Director , GIDE International Limited) |

Different metrics are involved when acquiring a mature business, compared to the acquisition of a high growth businesses; different for businesses that are heavy on the fixed assets and have long production cycles - also for those typically heavy on working capital and different ones again for a business that is a service driven; different ones with low margins vs high margins…; different when you are a trade buyer or financial investor. All this eventually forms part of very extensive Due Diligence Book.

In any case starting with Economic Value Added is a very good way. It is simple and opens up lots of doors to opportunities:
1. Assess Return on Capital employed vis a vis the Cost of Capital employed today and potential in the future (apply your Cost of Capital on the Capital Employed of the company you intend to acquire)
2. Analyse key factors that impact it (depends on the business model)
3. Consider your post acquisition ability to:
a. Increase or maintain existing revenues (while increasing margins)
b. Increase or maintain existing margins (while maintaining revenues)
c. Decrease or maintain capital employed (while a. or b. applies respectively or concurrently)

And at the end remember that the acquisitions most often fail not exclusively because of wrong valuations (unless it is fundamentally wrong) but because of an inability of the acquiring entity to integrate the business and business model of acquired entity…

Rudy Fischer
Title: Partner
Company: RKFischer & Associates
(Partner, RKFischer & Associates) |

Net Present Value of after-tax 'normalized' cash flows the business can generate. What to use as a discount rate? It is about risk! Higher risks require higher discounts which lower values. Those items that Emerson mentions go to risk.
Then there is the 'synergy' acquisition where if the technology works/fits, the sky could be the limit and valuation is in the eyes of the acquirer. :)

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