Challenging business valuations

Arnold ShieldsDolman Bateman & Co Pty LtdForensic Accountants

www.dolmanbateman.com.auwww.dolmanbateman.com.auChallenging business valuations in Family Law1Fundamentalswww.dolmanbateman.com.auValue of an asset is a function of it's future cashflowsWhat is value? Different concepts of value.Family Law = Value to ownerValue = Cashflows x riskIncome based valuations assume infinite life of business but discount rate means value after 10 years is negligible.25 Basic Valuation Methodologieswww.dolmanbateman.com.audiscounted cash flow,capitalisation of future maintainable profits,notional realisation of assets,value of net tangible assets (on an ongoing concern basis)capitalisation of future maintainable dividends. Wilde & Wilde [2007] FamCA 1044 (6 September 2007) at 1543Discounted Cash Flow (DCF)www.dolmanbateman.com.auSummaryThe discounted cash flow (DCF) value is the present value of the expected future streams of cash flows discounted at a rate which reflects interest rates and the risk associated with the business.4Discounted Cash Flow (DCF)www.dolmanbateman.com.auPros:Considered as the most accurate methodBasis for all other valuation methodologies

Cons:Rarely is information required available.High level of assumptions requiredMisunderstood5Future Maintainable Earningswww.dolmanbateman.com.auSummaryValue of Business is equal to Future Maintainable Earnings x Capitalisation FactorValue of Business is not Value of CompanyWill use past earnings as a guide for future profitability.

6Process of Future Maintainable Earningswww.dolmanbateman.com.auIdentification of tangible assets and liabilitiesRevaluation of assets to marketSeparation of balance sheet into business assets, surplus assets and financing liabilities.Determination of future maintainable earningsDetermination of capitalisation rateValue of business = FME x Cap RateGoodwill = Value of business less Net Business AssetsValue of Company = Net Business Assets + Goodwill + Surplus Assets - Financing Liabilities7Future Maintainable Earnings (FME)www.dolmanbateman.com.auValue of Business& GoodwillFuture Maintainable EarningsA$200,000CapitalisationFactorB3Value of BusinessC= A x B$600,000Net Tangible BusinessAssetsD$400,000Value of GoodwillE = C - D$200,000Valueof CompanyNet Tangible BusinessAssetsD$400,000GoodwillE$200,000Surplus AssetsF$50,000Financing LiabilitiesG($100,000)Value of CompanyH= D + E + F - G$550,0008Future Maintainable Earnings (FME)www.dolmanbateman.com.auProsEasily understoodCommonly UsedFewer assumptions than DCFConsDifficult to apply to high growth companies and those with abnormal capital expenditure requirements9Net Realisable Assetswww.dolmanbateman.com.auThe value of that shareholding is normally no less than that shareholders proportion of the estimated realisable value of the net assets of the company. The notional realisation of assets basis of valuation is normally only applied to businesses which do not produce an annual cash flow, or where, the outlook for a companys future earnings is either uncertain or the capitalised value of such earnings is less than the net realisable value of the assets employed.10Future Maintainable Dividendswww.dolmanbateman.com.auSummaryThe value is equal to present value of the future maintainable dividends discounted at a rate which reflects interest rates and the risk associated with the business.Used in minority interests only.11Future Maintainable Dividendswww.dolmanbateman.com.auProsUsed in minority interest valuations only, but other methodologies available.ConsDoes not take into account retained earningsDividend rate may be subject to other non-commercial considerations (payroll tax)12Definitions of Valuewww.dolmanbateman.com.auValue to Owner The concept ofvalue to owner considers and takes into account the benefits to a particular owner even though this may not be based on a hypothetical third party purchaser. Scott & Scott (2006) FamCA 1379 at 45:Fair Market Value - the price that would be negotiated in an open and unrestricted market between a knowledgeable, willing but not anxious buyer and a knowledgeable, willing but not anxious seller, acting at arms length.Special Value value to a particular purchaser - takes into account synergistic benefitsBook Value value recorded in books13Common mistakeswww.dolmanbateman.com.au#1 - Maths - the numbers just don't add up#2 - Two sets of books#3 - Rules of Thumb#4 - Methodology incorrectly applied#5 - Concept of Value - Value to owner#6 Independence#7 - Adjustments to Future Maintainable Earnings14Maths Errorswww.dolmanbateman.com.auExamplesValuation does not add upCritical Ratios incorrectly calculated (Sales Increase, Gross Profit %, Operating Profit %)Balance Sheets, Profit & Loss incorrectly summarised.Wrong amounts used in FME adjustments.Balance sheets not balancingAssets and Liabilities missed 15Two Sets of Bookswww.dolmanbateman.com.auManagement Accounts, Financial Statements, Tax Returns are all differentOne version for Bank and another for TaxIncorrect Accounting Treatment of TransactionsCash not declaredIntercompany Accounts not agreeing

16Rules of Thumbwww.dolmanbateman.com.auROTNo evidence to support basisUsed by Business Brokers to support priceUneconomic returnsOften include owners salary ie. Buying a job

17Treatment of Surplus Assets andFinancing Liabilitieswww.dolmanbateman.com.auWhat are Surplus Assets?Excess cash, property, investments, intercompany loans, directors loans.Financing Liabilities?Bank Loans, Bank Overdrafts, Directors LoansHire Purchase, Chattel Mortgage, Leases ?Security over personal or other non-business assets18Capitalisation Ratewww.dolmanbateman.com.auHave reasons for opinion been given?Positive FactorsNegative FactorsWithin Reasonable Range19Future Maintainable Earningswww.dolmanbateman.com.auBasis of Future Maintainable EarningsReasons for basisPast earnings are used as a guide to estimating performance.Sufficient Analysis of BusinessAdjustmentsSurplus assetsFringe BenefitsNon-recurring income and expenditure20Commercial Salarywww.dolmanbateman.com.auBasis of Commercial SalaryEvidence Salary Survey etc.Are they qualified to give opinion in this area?Base Salary or Total Package including Fringe Benefits such as Motor Vehicles21Summarywww.dolmanbateman.com.auDoes the valuation use an accepted method of valuation?Has the valuation methodology being correctly applied?Does it add up?Have reasons being supplied for opinions?Are reasons for opinions (FME & Cap Rate) supported by evidence?

22Questions?www.dolmanbateman.com.auArnold ShieldsDolman Bateman & Co Pty LtdPh: 02 9411 5422Email: ashields@dolmanbateman.com.auWebsite: www.dolmanbateman.com.au

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