Article written by:
Craig Hickey, CFA
Director, Valuation & Financial Opinion Services
The COVID-19 pandemic has affected virtually every business. For many businesses, this means closing retail locations, supply chain disruptions, reductions in demand and/or layoffs or pay reductions for employees. All of these impacts together equal declining revenue and profits and an uncertain outlook (many public companies are even declining to offer earnings guidance).
From a macro perspective, federal governments and central banks have launched unprecedented interventions into the markets. The U.S. Federal Reserve has lowered the federal funds rate to near 0% and has continued to purchase treasuries and other debt securities. Meanwhile, the CBO expects that the economy will contract sharply during the second quarter of 2020 as a result of the continued disruption of commerce stemming from the spread of COVID-19.
Many business owners are now wondering how all of these factors impact the value of their companies (which in many cases represents the majority of a business owner’s net worth). Valuation of a company typically comes down to expected growth and financial performance along with consideration of the risk in achieving the forecast. For valuation purposes, these expected factors are taken into account in an income approach such as the discounted cash flow method (i.e., forecasted cash flow discounted at an appropriate cost of capital) or a market approach such as a guideline public company or guideline transaction method (i.e., projected performance multiplied by an appropriate multiple based on the industry and perceived risk).
For many companies, the crisis has laid bare risks that had been unknown or overlooked and are now manifesting themselves in lower cash flows or higher risk (resulting in lower values). As such, now may be an opportune time to take a step back and examine your business’ risk profile and begin planning to manage the risk going forward. By partially mitigating or eliminating these risks, a business owner can better position the company for future shocks and decrease risk (and thus increasing long-term value). These considerations may include (but certainly not be limited to):
- Is the company’s geography limited? This could make the company more vulnerable to location-specific shocks while more diversified companies are able to better weather shocks in limited locations.
- Has the COVID-19 pandemic exposed any weaknesses in your customer base perhaps resulting in large non-payments? This could be a time to consider implementing revised accounts receivable policies or requesting retainers going forward from some weaker customers.
- Is there any customer concentration that is resulting in large swings in profitability? Increasing selling and marketing efforts to diversify a concentrated customer base could be a wise investment.
- Are the current number of vendors or suppliers limited or in distress? This is an ideal time to examine your supply chain in hopes of avoiding future disruptions.
- Has the current situation resulted in any issues relating to access to capital? Consideration may need to be given to managing cash balances differently or modifying policies around working capital.
Valuation is inherently a forward-looking exercise. Recognizing and mitigating risk factors along with planning how to take advantage of current market conditions are key components in driving long-term value.
GBQ’s innovative and forward-thinking professionals are ready to help you assess the impact on your organization – contact us.