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Manufacturing valuations are complicated and require key knowledge

May 17, 2013

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Appraising manufacturing businesses isn’t an easy task.

Multiple aspects of these companies have intangible assets that may provide value in addition to the value of a company’s hard assets. However, qualified appraisers can ascertain the value of manufacturing companies by applying various valuation methods, such as the income, market and cost (or asset-based) approaches. By considering these methods and choosing the most appropriate, valuators can come up with reliable value estimates.

Finding the right approach

Additional risks exist if the company doesn’t secure key relationships with long-term contracts or if contracts are soon to expire.To value manufacturing company assets, valuators consider and use one or some combination of these general approaches:

Income. This method converts anticipated economic benefits, such as earnings or cash flows, into a present value that takes into account the risk associated with a company.

Market. Using this approach, valuators analyze valuation multiples from acquisitions of similar businesses or from the stock prices of comparable publicly traded companies and adjust for the subject company’s particular characteristics.

Cost or asset-based. Valuators use various methods to determine the replacement cost or market value of a company’s assets, net of liabilities.

A manufacturer’s value generally is tied to its underlying hard assets, most notably receivables, inventory, machinery and real estate. So the cost approach is often relevant. But most manufacturers also possess a variety of intangible assets, including customer lists, brands, patents, formulas and proprietary processes. Because the income and market approaches can incorporate the value of intangibles, these approaches may more reliably estimate a firm’s entire fair market value.

But because manufacturing companies are quite asset-intensive, asset-based methods mayhave greater relevance and, therefore, may be weighted more heavily. As a result, appraisals of equipment, machinery and inventory play an important role in these valuations. Regardless of the appraisal approaches used, your valuator will need to visit the manufacturer’s facilities to view the hard assets.

Factoring in intellectual property
Despite the importance of hard assets to manufacturing operations, intangible assets also have a huge impact on value. In many cases, valuators can identify intangible assets manufacturers didn’t know they possessed.

For example, a company that develops a unique manufacturing process, technique or tool may be entitled to a patent or some other intellectual property protection. By taking steps to register or otherwise protect these assets, a manufacturer can enhance its value.

Understanding the workforce

Depending on the extent to which a manufacturer depends on skilled labor, the value of its “trained and assembled workforce” may be significant to its overall value. Typically, the most appropriate valuation approach for a manufacturer’s workforce is a cost approach.

For example, the valuator might estimate the cost — in terms of recruiting, hiring and training — of duplicating the manufacturer’s workforce. Or he or she might hypothesize a more cost-efficient workforce — a smaller number of more highly skilled employees, for example — that could match the current workforce’s output. The right method depends on the nature of the business and its industry.

Grasping the big picture

Foreign manufacturers may enjoy cost advantages — including cheaper labor, lower taxes, less stringent regulatory oversight and reduced risk of litigation — over domestic companies. Some countries, such as Mexico and Canada, benefit from free trade agreements with the United States.

However, offshore production has drawbacks — such as shipping and tariff costs, cultural differences, quality control issues, communication delays and oversight limitations — that may persuade customers to choose domestic suppliers. Manufacturers also face supply chain power imbalance. Valuators assess the relative power along a company’s supply chain and identify companies that represent 10% or more of a firm’s annual material purchases or revenues.

Additional risks exist if the company doesn’t secure key relationships with long-term contracts or if contracts are soon to expire.

Knowing when to ask for help

Bringing in a qualified appraiser is essential to obtaining an accurate valuation of a manufacturing business. In addition to understanding how to obtain an accurate value, he or she can help with accounting, finance and tax issues.

For more information contact Dennis McLaughlin, Chair of our Manufacturing Group or Kent Pummel, Chair of our Business Valuation Group, at [email protected] and [email protected]

All content provided in this article is for informational purposes only. Matters discussed in this article are subject to change. For up-to-date information on this subject please contact a Clark Schaefer Hackett professional. Clark Schaefer Hackett will not be held responsible for any claim, loss, damage or inconvenience caused as a result of any information within these pages or any information accessed through this site.

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