Negative Contributory Asset Charges

The multi-period excess earnings method (MPEEM) is commonly used to value the primary or most important asset responsible for the income-generating ability of a business enterprise. Typically, the intangible assets deemed to be the primary income-generating assets and valued using MPEEM are customer-related intangible assets and key technology. The MPEEM model estimates revenues and cash flows derived from the intangible net of the cash flow that can be attributed to supporting assets, such as a brand name or net working capital. These deductions are referred to as contributory asset charges and can be thought of as “economic rents” necessary for the main income generating asset to function as such.

Many technology-based companies (e.g. SAAS businesses) carry large deferred revenue balances on their balance sheet, which can translate into negative net working capital balances. This comes up frequently, in the context of the MPEEM and the calculation of the contributory asset charge on and of net working capital. However, the negative net working capital balance is typically not large enough that the subsequent contributory asset charge overcomes the cumulative charges attributable to the rest of the tangible and intangible assets responsible for the income-generating ability of the intangible asset in question. In a recent valuation, I came across a subject company that carried such a high level of deferred revenue that it maintained a significant negative net working capital balance that this aforementioned situation occurred. As is seen below.

image

At first glance, this seems counter-intuitive. After taking a step back, it occurred to me that with such a business model the company is essentially borrowing from its customers by collecting the upfront charge for the service. Or put another way, deferred revenue can be thought of as another form of short-term financing for business operations. Much like credit cards that are paid in full and don’t incur interest, consistent deferred revenue attributes more value to the key intangible asset and the enterprise as a whole.

By |2018-06-20T18:50:58+00:00April 8th, 2015|Financial, Valuation|Comments Off on Negative Contributory Asset Charges