At it’s most basic stripped down version establishing the market value using this technique involves the multiplication of an entities future maintainable earnings by the entity’s price earnings ratio. The surplus assets are then added to the value obtained by capitalising future maintainable earnings to arrive at an estimate of the total value of the company or entity being valued.
Listed below are 10 common mistakes we see when valuers use this technique for a business valuation:
- Previous years have recorded a loss. The FME approach requires a history of profitable trading.
- Using the most recent years profit as a proxy for the future maintainable earnings without assessing past performance and analysing likely future events.
- Failing to adjust prior years profits for inflation.
- Failing to exclude one off items or non-recurring profit and loss items from the assessment of future maintainable earnings.
- Failing to adjust for excessive or inadequate directors remuneration and personal expenses.
- Building in forecasts of growth into both the future maintainable profits and the price earnings ratio.
- Using a historically based future maintainable earnings value with a prospective price earnings ratio or vice versa.
- Once the valuation has been conducted we often see a lack of comparison to the valuation obtained through other valuation methods such as discounted cash flow valuations.
- Failing to account for surplus assets or surplus liabilities in the valuation.
- Failing to review the level of goodwill for reasonableness.
Conducting a valid and reasonable business valuation requires the valuer to consider a range of commercial, taxation, and other factors in arriving at the final valuation. For further information, please contact Rushmore on 1800 454 622 or visit our Business Valuations FAQs.