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• W190914169 abstract "(Tables and figures not shown) Setting a price, whether to buy or sell, on a privately held business has always been a problem. In contrast, price for publicly traded stocks is determined by the marketplace, and these markets are though to be efficient; that is, theoretically all available information about the value of these companies is used by buyers and sellers to price the stock. This means the stock trades at its true value, the value set by an aggregation of all potential buyers and sellers on the expected future earnings of a firm. There is no such mechanism for privately held businesses, especially for small businesses. Consequently, a number of rules of thumb have been used, each with its own proponents. Selling price has been determined to be roughly equal to: 1. One year's sales; 2. Four (or some other factor) times one year's profits; 3. Net worth plus one year's profits; 4. Net worth; or, most likely, 5. Some figure representing the best educated guess. However, concepts used to evaluate publicly traded financial instruments can be applied to evaluating small businesses. One concept of business valuation is based on the relationship between risk and value. It is generally accepted that greater risk means future cash flows should be discounted at a higher rate, thus yielding a smaller present value. This approach requires a reliable estimate of cash flows and an appropriate discount rate based on risk. Both considerations are discussed further and provide the basis for determinants of risk used in small business valuation. ESTIMATING CASH FLOW Cash flow estimates depend upon forecasts of sales and expenses. Several well-known methods of forecasting sales are available. Among them are trend extension, leading indicators, sales force estimates, and executive opinions, Of these, all would be available to the seller, but only trend extension and leading indicators are likely to be available to a buyer. Trend extension involves using some method such as linear regression or moving averages to generate a line through a set of data. This line, extended into the future, then becomes the predictor of interest. In this case, two projections are made, one for sales, and the other for expenses, where expenses include cost of sales. The difference for each year's projections becomes net income before taxes. Taxes can then be estimated and non-cash expenses (such as depreciation and leasehold improvement amortization) can be added back to obtain cash flow estimates for each year projected. Leading indicators are factors that are thought to predict or are otherwise related to sales of a particular business. For instance, the number of construction contracts let in a given region predict the level of contractor equipment rentals likely to occur in future periods. (Information like this can be obtained from F. W. Dodge and other industry sources.) Other examples of leading indicators include housing starts for those in building supplies or carpet sales, and agricultural product sales for farm machinery dealers. These figures may be used directly for short-term prediction or in a regression equation for a longer term estimate. That is, if housing starts are used as a predictor and they are up 10 percent one might assume that sales of an item related to housing construction will be up 10 percent soon. A more precise approach, however, is to use housing starts as an independent variable and sales as a dependent variable, then use these to derive a regression equation that expresses a relationship between the two. In practice, it is probably best to experiment with leading indicator figures that have preceded sales by some period of time, and determine the time lag that occurs between a change in that leading indicator and sales. Sales force estimates and executive opinions are basically the collective judgment of sales personnel and managers in the business. …" @default.
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• W190914169 date "1989-10-01" @default.
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• W190914169 title "Determinants of Risk Adjustment for Small Business Valuation in a Growth Industry" @default.
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