Business Valuation—Economic and Political Considerations
The impact of hoarded cash in valuations
The impact on business valuators in this economic and political climate is largely observational. Observational because any forecasted financial information installed in any formula must include the impact of managements’ sources and uses of “hoarded cash.”
U.S. stock markets are at record highs1 due to the continued earnings of public corporations2. Though unemployment is way above average, and the economy is limping along. We also are enduring divided government in our nation’s capital.
It appears to many experts that corporations are retaining their earnings and are refusing to invest in infrastructure or manpower. As corporate revenues and profits are on the rise, non-officer wages continue to stay flat. Corporations are “hoarding” cash3.
A divided government creates confusion and uncertainty that is at odds with prudence and management. If government, as a whole, does not clearly signal that—taxes will either increase or decrease, regulations will expand or demur, or government spending will expand or contract—business will continue to hold tight to cash given this uncertainty. As an example, all one has to do is try to forecast the impact of Obamacare’s costs and regulations on overall profits. This is yet to be determined, correct?
Business valuators should consider how these economic and political conditions could impact the valuation of businesses in this uncertain climate. The effects can be either positive or negative based upon the entity’s near future disposition of their “hoarded cash.”
Business valuators can employ an “excess cash” addition to value within their calculations. This may provide a “low-end value” as compared to considering the entity’s achievable forecasted sources and uses of “hoarded cash” on future operations.
The key is to understand how the businesses intend to expend their excess cash, if any, and include that impact into the projections. It is important to ensure that any forecasted financial statements provided by management reflect these intended actions. That is, if the impact is measurable, material, and probable.
Forecasted balance sheets and cash flow statements, along with income statements, would provide further assurance. The cash flow statements will disclose if management anticipates future “cash hoarding” or plans to expand future operations to grow the business through infrastructure and employee investments.
Business valuators’ preliminary calculations include either historical or forecasted researched financial information, or both. Many use Morningstar/Ibbotson’s infamous “blue book back flap,” which may or may not be published in 2014. We hope that the research will be provided in their “red book.” But no assurances have been provided in that regard.
If not, as valuators, we will have to sharpen our pencils, but that is the nature of the work. Much of the “sharpening” is ongoing within NACVA Board Committees. Chances are very good that resolutions will be forthcoming very soon, but I digress….
The bottom line is that the same risk rates that we have relied upon will be available for our reference. The information will reflect current and historical market trends. The primary focus for business valuators will be to test the assumptions and pin down accurate growth rates.
The impact on business valuators in this economic and political climate is largely observational because any forecasted financial information installed in any formula must include the impact of managements’ sources and uses of “hoarded cash.”
There should not be any direct effect to any “method” of calculation. The economic risk rates used to calculate discount, capitalization, and/or cost of capital rates will continue to be provided by dependable sources. These rates will reflect current economic conditions and assumptions, at the time, about the future. Of course, a higher growth rate must be considered if the entity anticipates employing their “hoarded cash” in the near future to grow operations.
Valuators can sometimes get buried in the details of their calculations and not fully gauge the entirety of the economic climate,—especially when the engagement requires a calculated value as opposed to a full valuation.
This missive is intended solely for your “food for thought.”
- Rooney, B. (2013, Dec 31). Stocks: 2013 is one for the record books. CNNMoney, Retrieved from http://buzz.money.cnn.com/2013/12/31/stocks-record-bull-market/?iid=EL
- http://blogs.marketwatch.com/capitalreport/2013/12/5
- ft.com/cms/13/11/27
John J. DeLuca, CPA, CVA, is currently the managing director of Succisa Virescit, LLC, an international consulting firm specializing in the areas of forensic accounting, litigation support, business valuations, and expert witness testimony. Mr. DeLuca’s experience spans more than 30 years of practice. John can be contacted at jdeluca@carpediemconsult.com.
