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Mergers &
Acquisitions
Keys to Creating a
Sustainable and Productive Financial Forecast
The McLean Group
Zane N. Markowitz, Senior Managing
Director, Market Intelligence
Brian Sullivan, CPA/ABV, Managing Director, Silicon Valley
Andy Smith, CPA/ABV, ASA, CVA, CMA, CPA/ABV, ASA, CVA, CMA, Senior
Managing Director, Valuation Services
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Summary: If you use private sales transactions when putting
together a market approach-based valuation, be careful about
normalizing the company’s earnings and then multiplying those
earnings by price-to-earnings ratios you find in databases such as
BizComps, Pratt Stats, and Done Deals. You’ll probably get an
incorrect value. Here’s why. |
A company’s future often is dependent on a business projection derived
from diligent and objective-directed gathering of competitive data and
market intelligence. These resources including data, facts and opinions
will project the sustainability of the company’s future growth and
margins. The validity and strength of the gathered information is
essential to developing a projection that management believes in, and from
which future company strategies and objectives can be created. How to
obtain quality resources that will contribute to an effective financial
forecast is a skill management and all business forecasters should be
expert. Not being able to create reliable financial forecasts will result
in flawed research, and will yield forecasts that have a greater chance of
failure.
Analyzing a Forecast
The value of any financial asset, stock, bond or business is a function of
the future cash flows it will generate. Accordingly, the quality of a
company’s forecast is critical to assess the business’s value and to make
sound business decisions. There are several processes that should be
considered when creating and analyzing a forecast, including:
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Time and Involvement –The more time and experienced
forecasting personnel dedicated to the forecasting process, the more
detailed and accurate the forecast will be. Executive management,
accounting and finance departments, suppliers and customers should
all be involved in the process. In addition to initially devoting a
wealth of time to the creation of the financial forecast, it needs
to be frequently reviewed and updated.
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Management’s Track Record – Consider the company’s track
record in meeting its forecasts. Actual performance will never
exactly match the forecasted performance, but it can serve as a
helpful benchmark to critically analyze where and how the forecast
missed its objective and how it can improve the next forecast.
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Identify and Analyze Key Value and Cost Drivers – Any new
proprietary technology and/or new business development teams that
are expected to bolster the company’s existing customer base are
examples of significant value drivers that should be analyzed to
estimate resulting increases in revenue and profitability. The
forecast also should analyze possible fluctuations in prices, raw
material costs and labor costs.
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Understanding KPIs – Key performance indicators (KPIs) are
financial and non-financial metrics used to help an organization
define and measure progress toward organizational goals. Historical
financial analysis alone is becoming an outdated and ineffective
management tool, however, when used with such non-financial, yet
quantifiable, metrics as “customer attrition,” “employee turnover”
and “manufacturing cycle time,” etc., the business’s performance and
inefficiencies can be best measured and identified.
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Compare Performance to Industry – Understanding the expected
direction of the industry may validate or identify soft spots in a
company’s forecast. Interviews with customers, raw material
suppliers and other stakeholders in the forecasted business arena
provide further insight into the industry’s future growth and
margins, and positively impact the business’s forecast. By comparing
the subject company’s historical performance and expected industry
performance, management is better able to analyze the proposed
forecast’s attainability.
- Know Industry Competitors
– Just as there are industry experts on the management team of the
forecasting company – there are numerous other experts at
associations, government agencies and competitor companies that have
a wealth of facts, data, opinions, and most importantly, different
perspectives. These resources provide true business intelligence and
having it is a strategic and tactical advantage.
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Know Customers’ Needs – Formally interviewing customers to
assess the company’s standing versus competitors’ regarding such
factors as price, quality, delivery, technology, etc. is invaluable
to any forecasting process. It also is important to determine if
customers intend to continue purchasing the same quantities of the
company’s products.
The Importance of Market Intelligence
Many companies often embark on market intelligence research by gathering
market-based data and evidence to support key assumptions related to their
business plan and forecast. This process is critical to analyzing the
sustainability of earnings relative to market realities.
There are two market intelligence techniques of forecasting: quantitative
and qualitative. Quantitative techniques (such as The Percent of Sales
Method and Trend Analysis) are best used when economic changes are
infrequent and are of little use in today's world of rapid change.
Conversely, qualitative techniques create better financial forecasts and
improve budgeting processes by identifying the organization’s major
strengths and weaknesses relative to competitors’. This enables the team
to better prioritize areas needing improvement, appropriately allocate
resources, and monitor progress toward growth and new market penetration.
Qualitative research includes primary sources (statistical surveys and
expert interviews) and secondary sources (internet searches, publications,
market reports and analyses, etc.).
Secondary research is static and cannot be queried as unfiltered and
untested Internet data dispense risky forecast inputs. To ensure that
secondary research is logical, timely and accurate, references and quoted
sources need to be credible and verified. Additionally, primary source
research requires a significant number of interviews with customers,
competitors and others in the forecast arena to fill in secondary research
holes and gaps.
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Methodology and Tools: Forecasting requires 3 types of
information derived from numerous sources in the forecast arena:
data, facts, opinion |
1)
Detailed Competitor Profiles (facts & data)
Profile all key players |
2)
Market Intelligence & Trends (opinions from all the players &
stakeholders) |
3) Customer Opinions
and Assessments (opinions and facts) |
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Business activity,
products, services
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Manufacturing
processes
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Raw materials
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Pricing
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Financial Data
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Sales and Marketing
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New product
development
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Competition
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Ownership and
management
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Strategies
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Facilities and labor
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Acquisition, joint
venture, partnering attitudes
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Value chain
marketing
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- Manufacturing
and information and technology trends
- Marketing
- Growth outlook
- Financial data
- Capacity issues
- Key factor
analysis
- Supply and
demand issues
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- Customer profile
- Major suppliers
- Key purchase
decision factors
- Value of price
versus differentiation
- Customer ratings
of major suppliers strengths and weaknesses
- Customers' unmet
needs
- Where the
customer sees the marketing going vs. players' opinions
- Special
questions
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Robust and carefully crafted financial forecasts mitigate decision-making
risk and implement a process whereby the value drivers and strategies of a
business are measured and managed. Prudent executives cannot afford to
base critical investment decisions on flawed assumptions that have not
been tested and validated against marketplace facts and opinions.
By: Zane N. Markowitz, Senior Managing Director, Market Intelligence;
Brian Sullivan, CPA/ABV, Managing Director, Silicon Valley; and Andy
Smith, CPA/ABV, ASA, CVA, CMA, Senior Managing Director, Valuation
Services. The McLean Group is a middle market investment bank. In addition
to mergers and acquisitions, the firm performs business valuations for
public and private companies for transaction, financial reporting, stock
option plan, and tax purposes. In addition, its affiliate McLean,
Markowitz and McNaugthon provides in-depth market intelligence for
strategic analysis. For further information see
www.mcleanllc.com
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