3 simple steps to valuable prospective financials
Rick Harris is the Director of Finance for a 35-person engineering services company. The company prepares annual budgets each year but never created a multi-year forecast.
The founder of the company is starting to contemplate
transitioning out of the business and is considering all available options from
creating an Employee Stock Ownership Plan (ESOP) to selling partial interests
to key members of management or even selling the company outright to a strategic
Rick knows that for all of these options, financing is
likely going to be necessary. As such, Rick understands that all of the
potential buyers are going to want to understand in detail the long term cash
flow generating ability of the company.
Rick reached out to Quist to get an understanding of best
practices in preparing financial forecasts.
Preparing Your Company’s Forecast:
Determine if a top-down or a bottom-up approach is best for the company.
In a top-down approach, management
estimates the size of the market available for their business, identifies
relevant factors in sales trends, and estimates what percent of the market the
company can capture.
Companies that experience little
deviation in cash flow from one month to the next or start-up companies that do
not have any accumulated sales data may benefit from a top-down approach.
Conversely, a bottom-up approach is
typically developed from spending plans by various groups within the company. A
bottom-up forecast looks at factors such as production capacity and department
specific expenses. A bottom-up forecast may benefit a seasonal business that
experiences significant variation in cash flows throughout the year.
Use historical results as a starting point.
Management identifies the salient
economic variables that correlate with its historical revenue and
profitability. Specifically, management determines:
Is expected revenue growth due to an increase in price or volume or both?
- Is revenue growth achievable given the current operating conditions of the company?
- Which operating expenses are fixed vs. variable? Will fixed expenses grow over time at a rate of inflation or another index? For variable expenses, how will costs vary over time and will increases or decreases accrue directly to the customer?
- If new products or services are in the pipeline, have all corresponding expenses been accounted for including additional overhead requirements as well as additional research and development and capital expenditures?
Benchmark the company’s forecast assumptions
If Management’s forecast is in line
with industry growth and profitability, there is a higher likelihood the
forecast is reasonable and achievable.
If the Company’s forecast outpaces
industry revenue growth or profitability, prospective buyers want to understand
how the company is uniquely positioned to achieve above market financial
After further discussion with Rick, he faced three major
He was under some time pressure to get the financial forecast completed.
Once the founder had decided to explore
transition options, he started to think more and more about life after the company.
This accelerated his desire to find a solution about how to transition the
ownership of the business.
The sooner the forecast was completed, the
sooner the company could be transitioned.
He did not have a roadmap for preparing the financial forecast.
Clearly a top-down approach was going to make
sense, but he had a number of other projects on his plate and creating a forecast
from scratch meant he had to shuffle around other priorities.
He did not have readily available industry benchmarks to determine if the company’s
long term forecast was reasonable.
To be honest, the founder had always managed
the company to a zero profit to mitigate his tax liability, so Rick never gave
too much thought about if the company’s performance on a normalized basis would
exceed or fall short of its industry peers.
Rick took advantage of Quist’s Forecast Modeling
solution, which walked him through a series of questions to capture
major inputs and assumptions for the forecast.
Once Rick completed this first step, he had a starting draft
of a long term forecast. He then scheduled some time with one of Quist’s valuation
experts to build out some scenario analysis and sensitivity charts.
Within just a few hours, Rick had a working financial
forecast model that he could present to the founder that illustrated a number
of different forecast scenarios.
Have questions about valuing your business? Quist Valuation can
help. Let’s set a time for a free 30-minute consultation. We can discuss the
specifics of your business and identify the next steps needed to assess the
value of your company.
Schedule your free 30-minute consultation here.