Gearing up towards the end of the year or financial year-end, you are most likely busy compiling your business strategy, budgets and forecasts for the year that lies ahead. But, are you truly taking the most critical objective of most profit-driven businesses into consideration – which is to build maximum shareholder value? We address some of the most burning questions around the relevance of a business’ valuation in such a budgeting and forecasting process, as well as key elements that must be taken into account – to help achieve this objective.
What is the relevance of a business valuation in forecasts?
In the discounted cash flow (DCF) valuation method, a forecast is used to estimate the enterprise value (EV), which is the value of the business operations itself. However, this value is typically based on its expected future cash flows – and not necessarily only profitability. A lot of budgets and forecasts are predominantly focused on the income statement, which basically projects future losses and profits – without considering the wider impact of cash flows.
There is a significant difference though. Simply put, your cash flows refer to your net balance of cash that moves in and out of your business, which is in turn affected by several other factors. One such factor is how your working capital is managed. This is of course the capital which is used in the day-to-day trading of your operations, and is calculated as your current assets, minus current liabilities.
Another important factor that could have a significant impact on your EV, is your capital expenditure (CapEx) which refers to the money that your business is spending to buy or improve any fixed assets such as property, equipment and vehicles.
Does maximum profit auto equate to maximum value?
The purpose of budgets and forecasts is to support the business strategy to drive profitability. However, one must not lose sight of the ultimate goal – which is to optimise shareholder wealth in the long-term. And optimal profitability does not necessarily equate to optimal value.
For example, you could start taking undue risks to increase profitability, which could very well decrease the value of your business if failures materialise. Or, you could start to engage in non-sustainable business practices, such as not being stakeholder-centric, or following non-ethical approaches in your operations. This is bound to negatively impact the business, sooner, rather than later.
Another risk of focusing on profitability only, is that it could notably downplay other vital drivers of value, such as the overall business risk environment, capital structure, working capital management and an adequate but disciplined CapEx programme.
What is the impact of the forecast on the business value itself?
Considering the comprehensive impact of forecasting on the EV, you’ll also understand why it is essential to actually budget and forecast with the end goal in mind. This could be done by scenario analysis of different detailed assumptions to evaluate its impact on the profitability, cash flows and ultimately – the value of the business. Such an exercise will also provide you with useful insights on what the sensitive value drivers are, so you can develop a strategic roadmap accordingly, and prioritise courses of action – over the forecast period.
How to easily conduct an advanced forecast to determine business value in advance
At Worth.Business, we built an advanced forecast option into our online business valuation platform, which can be conducted at a fraction of the time and cost of a conventional, manual business valuation. Amongst other, it enables you to set numerous assumptions for each forecast year, which you can then effortlessly adjust and conduct several sensitivity analyses with.
Essentially, it enables you to measure the impact on business value, cash flows and profitability in advance, through a dynamic and instant display in the application. This empowers the ‘forecaster’ to mastermind the most business value-efficient strategic plan and areas of focus. Test the effectiveness of this cutting-edge online business valuation application first-hand, by registering for your obligation-free, complimentary trial period today.