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When Valuing a Manufacturing Business, Work With a Pro October 2014 Prepared by: Matt Crane, CPA, Partner Appraising manufacturing businesses isn’t an easy task. Multiple aspects of these companies have intangible assets that may provide value in addition to the value of a company’s hard assets. However, qualified appraisers can ascertain the value of your clients’ companies by applying various valuation methods, such as the income, market and cost (or asset-based) approaches. By considering these methods and choosing the most appropriate, valuators can come up with reliable value estimates. Finding the right approach To value manufacturing companies, valuators consider and use one or some combination of these general approaches: Income. This method converts anticipated economic benefits, such as earnings or cash flows, into a present value that takes into account the risk associated with a company. Market. Using this approach, valuators analyze valuation multiples from acquisitions of similar businesses or from the stock prices of comparable publicly traded companies and adjust for the subject company’s particular characteristics. Cost or asset-based. Valuators use various methods to determine the replacement cost or market value of a company’s assets, net of liabilities. A manufacturer’s value generally is tied to its underlying hard assets, most notably receivables, inventory, machinery and real estate. So the cost approach is often relevant. But most manufacturers also possess a variety of intangible assets, including customer lists, brands, patents, formulas and proprietary processes. Because the income and market approaches can incorporate the value of intangibles, these approaches may more reliably estimate a firm’s entire fair market value. But because manufacturing companies are quite assetintensive, asset-based methods may have greater relevance and, therefore, may be weighted more heavily. As a result, appraisals of equipment, machinery and inventory play an important role in these valuations. Regardless of the appraisal approaches used, your valuator will need to visit the manufacturer’s facilities to view the hard assets. Factoring in intellectual property Despite the importance of hard assets to manufacturing operations, intangible assets also have a huge impact on value. In many cases, valuators can identify intangible assets manufacturers didn’t know they possessed. For example, a company that develops a unique manufacturing process, technique or tool may be entitled to a patent or some other intellectual property protection. By taking steps to register or otherwise protect these assets, a manufacturer can enhance its value. Understanding the workforce Depending on the extent to which a manufacturer depends on skilled labor, the value of its “trained and assembled workforce” may be significant to its overall value. Typically, the most appropriate valuation approach for a manufacturer’s workforce is a cost approach. For example, the valuator might estimate the cost — in terms of recruiting, hiring and training — of duplicating the manufacturer’s workforce. Or he or she might hypothesize a more cost-efficient workforce — a smaller number of more highly skilled employees, for example — that could match the current workforce’s output. The right method depends on the nature of the business and its industry. Grasping the big picture Foreign manufacturers may enjoy cost advantages — including cheaper labor, lower taxes, less stringent regulatory oversight and reduced risk of litigation — over domestic companies. Some countries, such as Mexico and Canada, benefit from free trade agreements with the United States. However, offshore production has drawbacks — such as shipping and tariff costs, cultural differences, quality control issues, communication delays and oversight limitations — that may persuade customers to choose domestic suppliers. Manufacturers also face supply chain power imbalance. Valuators assess the relative power along a company’s supply chain and identify companies Boulay 7500 Flying Cloud Drive Suite 800 Minneapolis, MN 55344 (t) 952.893.9320 (f ) 952.835.7296 BoulayGroup.com Member of Prime Global, A Global Association of Independent Firms 1 When Valuing a Manufacturing Business, Work With a Pro that represent 10% or more of a firm’s annual material purchases or revenues. Additional risks exist if the company doesn’t secure key relationships with long-term contracts or if contracts are soon to expire. Knowing when to ask for help Bringing in a qualified appraiser is essential to obtaining an accurate valuation of a client’s manufacturing business. In addition to understanding how to obtain an accurate value, he or she can help your business with accounting, finance and tax issues. To learn more about “When Valuing a Manufacturing Business, Work With a Pro,” contact your Boulay advisor at 952-893-9320 or learnmore@boulaygroup. com. Boulay provides the information in this article for general guidance only, and does not constitute the provision of legal advice, tax advice, accounting services, investment advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal, or other competent advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation. Tax articles in this e-newsletter are not intended to be used, and cannot be used by any taxpayer, for the purpose of avoiding accuracy-related penalties that may be imposed on the taxpayer. The information is provided “as is,” with no assurance or guarantee of completeness, accuracy, or timeliness of the information, and without warranty of any kind, express or implied, including but not limited to warranties of performance, merchantability, and fitness for a particular purpose. 2