Przegląd Piekarski i Cukierniczy, October 2018
The fundamental piece of information for a buyer is the company’s price. The price should be proposed by the seller, because the seller initiates the entire transaction process. To determine the price, the services of an appraiser must be used. Property appraisers are the type encountered most frequently on the services market. Appraisers specialising in company valuations are relatively difficult to find.
You can value a company yourself. The principles are relatively simple, and valuing a bakery independently should not cause anyone much difficulty. Knowing the valuation principles also makes it possible to check which valuation criteria the purchasing party adopted when preparing the due diligence.
Asset-based valuation
The valuation should begin with the fixed-asset register. This is a list of our non-current assets, such as equipment, means of production, vehicles and computers. It also includes real estate and intangible assets. The total value of fixed assets and intangible assets is found on the company’s balance sheet. Both on-balance-sheet and off-balance-sheet records are used for the valuation. The latter contain fixed assets that have already been fully depreciated and have a carrying amount of zero.
Both the on-balance-sheet and off-balance-sheet fixed-asset registers contain the net and gross values of fixed assets. Gross value is the value at which the fixed asset was acquired. Net value is the acquisition value less the accumulated depreciation to date.
There is also a third value of fixed assets: replacement value or market value. This is the amount that must be spent to purchase a similar fixed asset with a similar level of utility and wear. Some things cannot be purchased on the secondary market. Used software or dedicated fire-protection systems cannot be purchased. Such fixed assets and intangible assets should be valued at their acquisition value.
With the fixed-asset register in front of us, the market value of each asset component can be determined approximately. The sum of the values of these components will constitute the company’s asset value.
Financial valuation
As I mentioned in previous articles, a healthy, prosperous bakery or confectionery is not sold by liquidating its assets. A company is a complex mechanism whose launch and operation require the attainment of a competitive advantage and the organisation of work, contracts with suppliers and customers, a good brand, unique recipes and good locations for retail outlets. The non-asset elements listed here are called goodwill.
Financial reporting includes three basic types of statements: the balance sheet, which shows the company’s assets and their sources of financing; the profit and loss account; and a combination of the two preceding statements—the cash-flow statement, also called cash flow.
Cash flow begins with the income statement; it contains revenue and cost items and the net result. This result is adjusted for balance-sheet items, including accounts and depreciation. The result of the cash-flow report is the total cash generated in the company’s account during the reporting period.
If the bakery’s accountant does not prepare a monthly cash-flow statement, data obtained from the bank or data contained in the balance-sheet items “cash in the bank account” and “cash on hand” may be used.
The value of a bakery is the sum of the cash generated each month in the company’s account over a period of four or five years, adjusted for the residual value, that is, the theoretical buyout value.
Unfortunately, there is discretion in determining the cash-generation period used to value a company. In the United States, which has the world’s largest market for trading family businesses, this period ranges from two to four years, and residual value is usually not used. A simple test can be used to determine how many years should be adopted in the equation defining the bakery’s value. Each question should be answered with a number on a scale from 1 to 5, where 5 means very good and 1 means very poor. At the end, the points should be totalled, the average calculated and then rounded up to a whole number.
The test
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Does the bakery or confectionery have a strong, well-recognised brand in the market, and does it stand out from its competitors (5 points)? Or is the brand poorly recognised or associated with an image or quality problem (in which case, 1 point)?
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Are the bakery’s or confectionery’s retail outlets located optimally? If the location is very good—5 points.
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Is the bakery managed with the support of key employees engaged under solid employment contracts (in which case, 5 points), or is it managed solely by the owner, while key employees are paid below the industry average?
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Does the bakery’s main sales activity take place continuously, every day (in which case, 5 points), or unevenly and occasionally (in which case, 1 point)?
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Does the bakery or confectionery sell exceptional products that are difficult to copy (5 points), or does it sell typical products that competitors can easily copy?
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Does the bakery have several wholesale customers who purchase 20–30% of its production (in which case, 1 point), or mass-market customers (in which case, 5 points)?
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Does the bakery keep its accounts properly, with cost and revenue centres separated and the results of different types of activity shown (5 points), or do the accounts show only the combined financial result and taxes payable (1 point)?
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Does the bakery have procedures, rules and an IT system that simplifies management of the company (in which case, 5 points), or does it lack all these elements, which significantly facilitate the company’s takeover by new management?
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What was the growth rate of revenue and profit over the last three years? If revenue and profits declined, enter 1 point; if they remained unchanged, enter 3 points; if they increased, enter 5 points.
The average of the points collected should now be calculated and rounded up to a whole number. The resulting average should then be multiplied by the annual cash-flow value, that is, by the amount of cash the bakery generated during the previous year. The product is the bakery’s current value.
Earlier, we obtained the bakery’s value on the basis of the sum of the replacement values of its fixed assets and intangible assets.
If it turns out that the bakery’s value calculated on the basis of the cash it generates is lower than the value obtained by valuing its assets, it is better to sell the company by liquidating its assets than to sell it to an investor as a whole.
The example presented here is helpful in valuing a bakery independently and also indicates what should be considered when building the company’s value. Ultimately, the owner is not the appropriate person to assess their own company, because such an assessment will be highly subjective. Nevertheless, the owner should know the outline of the valuation methodology, how the value can be shaped, and how to assess the valuation performed by an investor during due diligence.
Wojciech Moszczyński