Evaluating Business Projections

If we could predict the future, it’s fair to say that many of us would not have our current day jobs (if we worked at all).  It is fun to daydream.  However, evaluating what might happen in the future is a big part of what we do as business appraisers, as businesses are valued primarily on the basis of expected future cash flows.  How ironic.

Our clients are typically the best informed when it comes to developing projections for their businesses. However, as valuation professionals, we have a responsibility to assess the reasonableness of projections provided to us, along with their underlying assumptions and bases.  This exercise is best performed using multiple frames of reference.  Evaluating projections from multiple perspectives is much the same concept as considering multiple approaches to valuing a business, in that if one view is flawed, that will be flushed out in reconciling to the other approaches and forming the overall picture.

There is no magic formula to evaluating projections, but I like to think that at a minimum, there are three high-level questions to ask of any set of projections when assessing merit:

How do the company’s projections compare to actual historical results?  This is the basic starting point for most of us, which includes horizontal and vertical analyses to identify trends in the financial statements.  We all know the adage that past performance doesn’t guarantee future results.  Sure, but history is a great place to start when trying to guess what will happen next.

How do the projections compare to industry peers and market forecasts?  Companies that forecast robust growth must either: (1) be in a growing market; (2) be able to capture market share from their competitors; or (3) find new markets to enter.  Without clear support for one of these three conditions, forecasts for growth are little more than wishful thinking.  Industry and market analyses help an appraiser evaluate the potential for growth within a given market, and competitive analysis helps to clarify how a subject is positioned relative to its peers.  Companies that wish to grow market share should be able to explain how they will take that share from competitors, and why.

Do company projections match its specific circumstances and business plan?  A company that is forecasting aggressive growth must also budget for the required increases in manufacturing, marketing, and financial capacity.  Also, a company that has had initial success in one market should carefully assess its ability to replicate that success in new markets where the competitive landscape could be more challenging.  Forecasts must also incorporate specific covenants of existing or proposed financing arrangements.

Of course, there is no way of knowing what the future holds.  But being able to ask the right questions is a useful skill when evaluating whether a company’s projections hold water.

 

By |2018-06-20T18:52:19+00:00May 27th, 2014|Valuation|Comments Off on Evaluating Business Projections