Welcome back to the seventh installment of our series on business valuation. In previous articles, we've explored various aspects of evaluating a business's worth, from market and industry conditions to company maturity and reputation. Today, we delve into the critical topics of viable growth potential and pro forma analysis, shedding light on the future outlook that underpins a business's value.
Looking Beyond the Past
As a prospective buyer, one of the foremost questions on your mind is likely, "What does the future hold for this business?" While historical financial performance is undoubtedly essential, the forward-looking aspects truly drive a business's value. After all, investments are made with an eye on future returns, not past achievements.
Verifiable Growth Potential: The Key to Confidence
When assessing a business's growth potential, the term "verifiable" is paramount. It's all too common to encounter sellers armed with ambitious projections that lack any semblance of realism. In such cases, discerning the genuine growth potential becomes an intricate task.
One method of verifying growth potential is to examine a business's historical track record. Have they consistently expanded whether through opening new locations or expanding their product or service offerings? Trends like these suggest that the company's growth is not a mere pipedream but grounded in past achievements.
In cases where a business is entering uncharted territory, such as launching a new product line, the verifiability of growth becomes more complex. In such instances, a comprehensive understanding of the industry, market research and feasibility studies become vital. The more data points you can collect to support growth assumptions, the more confidence you can have in the business's future prospects.
The Role of Pro Forma Analysis
Pro forma analysis plays a pivotal role in assessing growth potential. It involves creating financial projections based on various scenarios, often incorporating assumptions about future revenue, expenses and other key metrics. Pro forma statements are not limited to the income statement; they can extend to balance sheets and cash flow statements, offering a holistic view of a business's future financial health.
Consider a scenario where a business has secured a substantial contract expected to boost revenues significantly. Pro forma analysis helps assess the impact of this contract on the business's financials. It allows you to gauge whether the assumptions underpinning this growth are realistic and sustainable. Furthermore, pro forma analysis helps uncover potential bottlenecks, such as the need for additional working capital to support increased operations.
The Franchise Model: A Proof of Concept
In the world of franchising, verifiable growth potential often takes on a different dimension. Franchise businesses benefit from a proven concept that has been replicated successfully across multiple locations. Franchisees can look to historical data from other branches to gauge their potential success.
Franchises are appealing to buyers precisely because they come with a built-in model for success. However, it's essential to ensure that the franchisee adheres to the established system. Deviating too far from the proven formula can lead to a loss of success. Therefore, when considering the purchase of a franchise, evaluating the franchise's historical performance and the level of conformity to the established system is crucial.
Contracts and Exclusive Agreements: The Verifiable Edge
Contracts and exclusive agreements can significantly impact a business's growth potential. For instance, a company may have secured a multi-year contract with a major client, ensuring a stable stream of revenue. In this case, the verifiability of the contract's terms and the likelihood of its renewal are pivotal factors.
Similarly, a business with exclusive agreements to distribute or manufacture certain products can enjoy a competitive advantage. Pro forma analysis can help assess the long-term impact of these agreements on the business's financials, allowing buyers to make informed decisions.
Final Thoughts
In the world of business valuation, understanding a company's viable growth potential and conducting a thorough pro forma analysis are non-negotiable steps. Whether you're considering a startup, an established business or a franchise, the ability to verify growth assumptions and project future financial performance is key to making sound investment decisions.
As you navigate the complex terrain of business valuation, remember that the devil is in the details. The more robust your data, the more accurate your projections, and the more confidence you can have in the business's potential. Stay tuned for the next installment in our series, where we'll continue to demystify the world of business valuation by talking through the importance of the quality of your books and accounting records.
If you missed last month’s article, take a look at our discussion of Evaluating Year-to-Date Sales and Profit - A Crucial Aspect of Business Valuation
About Transworld Business Advisors of the Gulf Coast
Transworld Business Advisors of the Gulf Coast covers the northern Gulf Coast along the I-10 & I-65 corridors with special emphasis in Mobile, AL to New Orleans, LA. We strive to be the top business brokerage firm in the area and leverage our extensive experiences and our international Transworld platform to run confidential and competitive business sales processes. We help entrepreneurs to buy a business or sell a business, with a focus on helping family-owned and closely held businesses with their strategic plans for the future. Transworld offers a wide range of advisory services to the northern Gulf Coast Region, including Alabama, Mississippi, Louisiana and the Florida panhandle, that are tailored to fit your business needs, whether you’re buying, selling, preparing to sell, or franchising.
If you are ready to sell or would like assistance getting your business ready to sell, reach out today at [email protected].
