Article written by:
Forensic and Dispute Advisory Senior
When a valuator prepares a business valuation, generally one of the measures of value is some multiple of the cash flow available for the business after paying all expenses, including taxes. As you may know, The Tax Cuts and Jobs Act of 2017 (“TCJA”) reduced the tax rate for C corporations and individuals. While it is true that the reduction in tax rates has led to an increase in cash flow, that does not necessarily correlate to a direct increase in business value. The question that valuators and business owners need to be asking is – how is the additional cash flow being used?
Businesses can take several approaches to use the new influx of cash. For example, businesses could (and some did) increase wages and bonuses in an effort to stay competitive and increase employee morale. Businesses may also use additional cash for capital expenditures or investments in research and development. These investments (wages, capital expenditures, research, and development) may not necessarily have an immediate positive impact on the bottom line, but would rather be investments back into the company. Alternatively, some companies may choose to make no changes to their operations, which would allow the additional cash to hit the bottom line.
All of these different approaches to using the TJCA have a unique impact on the available cash flows and thus the value of each business. Accordingly, in order to determine if the value of a business has changed as a result of the TJCA, it is not enough to simply consider the tax savings. It is also necessary to consider how the business has used those tax savings.