Add Stock on Top of a Business Valuation? Say What?

As an independent business valuer I get to see lots of valuations done by others. Some are great, some make me cringe. One of the most common mistakes I see is when stock or other operating assets like trade debtors are added on top of the business valuation.

When using an earnings multiple or discount cash flow method, the value calculated is generally an enterprise value. This value already includes everything necessary to operate the business at the expected levels of profitability. For this value the purchaser gets everything necessary for that price.

This value already includes an ordinary amount of working capital, equipment, and intellectual property. To add any of these on top of the valuation would mean that the rates of return would change, making the valuation plain wrong.

You would be forgiven for thinking that this is a rookie error made only by up and coming valuers. Just the other day I witnessed this error being made by a business broker who was providing his expert opinion for a shareholder litigation case. He had been writing these kinds of expert reports for a long time, and I’m probably the first person to point out that his method is not supported by any valuation text book I’ve ever seen. I was sure to point this out to the solicitors on both sides in my critique of his report.

Forgive me for my cynicism, but this is the problem with the regulation landscape for business valuations in Australia. There is no regulation. So if you can convince people you are a good valuer then you get the job. I recently wrote an entire article about what to look for in a good business valuer. You might want to look it up.

The lesson: Business valuations using any earnings method already include the value of operating assets and liabilities. To add these on top would be double counting. But beware that any non-operating assets or liabilities are adjusted to the value of the business as a final step. The key is to understand the difference between operating and non-operating. This is done case-by-case and is a matter of judgement. No spreadsheet or automated software will do this thinking for you.

Follow me on facebook, linkedin, twitter and google+ for more.