Do you understand what your manufacturing company is worth?
Whether you are reaching retirement or have received an offer to sell, it is crucial to understand what value means for a business. The value of a company is generally determined by using three different approaches:
Asset approach: The asset approach is used by determining the fair market value of the assets and liabilities inside a business. This method uses appraised or actual values at a given date. In some instances, this method is the most probable and unbiased compared to the other two. However, it does not consider the earnings potential of the subject business.
Income approach: The income approach either focuses on the business’s current or potential revenue and expenses. The value(s) are capitalized or discounted back to the date of valuation, respectively. This method is more complicated than the asset approach because it uses current or potential earnings, cash flows, and an estimated return rate. The income approach generally requires the highest level of professional judgment to determine a value.
Market approach: The market approach compares similar companies that have been previously sold to determine a value. This approach requires professional judgment since it relies on the economic and industry conditions and intangible value of a business associated with customer connections and team experience.
Due to most manufacturing companies relying heavily on assets for operations, business valuation experts will commonly use an asset-based approach to value the business. In terms of developing a value, professionals will typically review all valuation methods and determine which is most practical based on professional judgment.
Now that the big picture of determining a value has been established, it is essential to investigate more company-specific attributes.
What industry does the company operate in? What is the current economic landscape?
How has the company performed financially in the past, and how does it expect to perform in the future?
These are all valid questions that should be answered when beginning the process of preparing a business valuation.
To cater to the topic at hand, we will start by analyzing the subject company’s industry. The manufacturing industry is generally defined as companies engaged in transforming raw materials into new products using mechanical, physical, or chemical methods. In some instances, assembling of parts into new goods is included in this industry. Finished products may be sold directly to consumers or wholesalers for resale. In general, companies in this industry heavily rely on debt financing and are asset intensive. Companies in this industry vary significantly due to the products each business manufactures.
According to the IBISWorld August 2020 Report for Manufacturing in the United States, over the five years to 2025, the manufacturing sector’s revenue is forecast to return to growth. Sector revenue is expected to increase at an annualized 3.6% rate to $5.6 trillion over the five years to 2025. Rebounding commodity prices and renewed demand, both in the United States and abroad, are anticipated to facilitate accelerated revenue expansion for manufacturers. The report later discusses the uncertainty surrounding the COVID-19 pandemic and that forecasts do not provide a guarantee. Regardless, the industry consensus remains optimistic for manufacturing companies to experience growth in the foreseeable future.
A term often used for industry-specific business valuations is “multiples.” Buyers and sellers in the market want to know what type of multiple will be received for a business’s potential sale. A multiple is a number generally used to convert earnings before interest, taxes, depreciation, and amortization (EBITDA) or sales into a business value.
Example: If the current multiple of EBITDA in the manufacturing industry is 4.5, a company with current earnings of $100,000 would expect a fair market value of roughly $450,000.
While multiples can be skewed by company size and outlying sales transactions, it is an excellent way to develop a range of value for a subject business.
One commonly used method to determine if a manufacturing business meets expectations is comparing it to current industry benchmarks and key performance indicators. To understand how indicators affect value, it is important to be aware of the most common in the manufacturing industry:
Customer return rate
Planned maintenance %
Note: The key performance indicators above may not apply to every manufacturing company based on specific operations.
If applicable, it is essential for business owners and managers to know how each is calculated and how their business continually compares to industry standards. Business valuation professionals should have access to research databases that collect each sector’s information within an industry. Common data used are industry benchmarks, multiples for sale, and previous sales reported to the database. All of the information provided for each sector is used in a business valuation to determine if a subject company meets the industry’s expectations.
Questions about your Manufacturing Company’s is Worth?
If you are interested in learning what creates value in a business or want to know more about the steps to complete a business valuation, please contact our team today! Our team of Certified Valuation Analysts are experienced in practicing all the above valuation approaches to perform credible business valuations for a wide variety of clients.
Ways Manufacturing businesses can prioritize and improve cash flow
During these uncertain times, manufacturing companies face many challenges. Making cash flow a priority is something every manufacturing company owner needs to keep in the forefront of their mind. With the potential loss of work, change in timing for projects, increased costs for raw materials, and fewer project opportunities, many companies have begun to experience tighter cash flow. Below are strategies to help prioritize and improve cash flow in your manufacturing business.
1. Accelerate Receipts
Bill early and often, as the contract terms allow. The sooner you can get invoices out, the sooner you are likely to receive payment. Consider including upfront customer deposits or milestone payments for customers who have long-term projects. This will help to bring in cash flow ahead of time or over the life of the project. These customer deposits can cover the upfront costs related to the long-term order, which previously may not have been received until project completion.
Additionally, ask for payment when invoices become due. Do not allow unpaid invoices to accumulate and grow old. Also, consider adopting new policies and letting your customers know about it. Examples include having all invoices due on receipt or charging a penalty, interest for unpaid invoices within 30 days, or stopping work for a customer if payment is not received within 60-90 days for previous projects.
2. Defer Payments
Consider checking with vendors if they would allow you to defer your payments until a later date. Review your upcoming expenses and determine whether these items are required considering the current pandemic environment. Additionally, review your insurance policies, phone plans, health care plans, and any other plans to find savings, especially if you have not done so recently.
3. Renegotiate Terms with Banks & Vendors
Renegotiate terms of your line of credit agreements or other long-term debt agreements. Interest rates have dropped significantly in 2020. If you have a minimum interest rate on any variable debt agreements, now may be a good time to review and renew.
Go into the renegotiations with a plan. Do not be afraid to ask for a fee reduction and let the bank know that you monitor the fees and continue to do so. Consider extending the length of your renewals. Many bankers prefer to freeze pricing for 3-5 years as it is less likely for the client to switch banks. Many companies make the mistake of negotiating pricing every year, which leads to lower prices, but could risk damaging the banking relationship.
Renegotiate terms with your vendors, but do not just focus on price. Negotiating for a discount related to early payments, requesting extended payment terms, or paying with a credit card can help improve cash flow while maintaining a positive relationship with key vendors.
4. Improve Inventory Management
Thoughtful inventory management is an easy way to improve cash flow. Liquidating excess or slow-moving inventory by finding a single large bulk purchaser or asking the distributor you originally purchased to buy it all back. Although you will likely be charged a fee to do so, this removes the inventory and can improve cash flow.
Manufacturing companies should also re-evaluate how much inventory needs to be kept in stock. Reducing the overall value in inventory may result in a simple improvement in cash flow. Additionally, manufacturing companies should consider establishing new purchasing procedures with an approval process to avoid over inventory purchasing. Do not make large purchases to get volume discounts if the purchased materials will not be used quickly.
5. Sell Assets
Review your listing of fixed assets to determine if any non-productive assets can be sold. These could be old items that have not been used for a while, or items no longer being used due to the pandemic’s reduced workload.
6. Take Advantage of Tax Opportunities
The Research and Development (R&D) Tax Credit is one of the best opportunities for businesses to reduce their tax liabilities, improve cash flow, and increase earnings-per-share. The R&D credit is designed to reimburse manufacturers who develop new products or inventions and offer a significant percentage back to qualified research activities and expenses. There is no limitation on the amount of expenses and credit that can be claimed each year. Smith Schafer can examine your company’s activities and determine which areas are eligible for the R&D tax credit.
Qualified Improvement Property (QIP) is now a 15-year, bonus depreciation eligible property, after the CARES Act provided a technical correction from Tax Reform in December 2017. QIP is a tax classification of assets generally including interior, non-structural improvements to nonresidential buildings placed in service after the buildings were initially put into use.
Net Operating Losses Carrybacks
The CARES Act introduced five-year net operating loss carryback opportunities for losses arising in taxable years after 2017 and before 2021. Suppose the taxpayer has a chance to carry back a 2018, 2019, or 2020 loss. In this case, it may be beneficial to maximize the loss to the extent that there are income and associated taxes to recover during the five-year carryback. A downturn in the economy offers many unique opportunities to enhance such losses.
Cost Segregation Study
These studies are among the most valuable tax-saving strategies available for manufacturing companies. A cost segregation study’s primary goal is to identify all construction-related costs for a manufacturing facility that can be depreciated over a shorter tax life than the building, which is up to 39 years for nonresidential real property.
Questions about applying these cash flow tips in your business?
How can we help your manufacturing business plan for the future? We work with approximately 100 Minnesota manufacturing companies helping them grow with accounting, tax, and consulting solutions. Contact us today to schedule a consultation with one of our industry experts.
Internal fraud drains more than $3.7 trillion dollars annually from global businesses, according to the Association of Certified Fraud Examiners (ACFE). According to ACFE’s latest Report to the Nations, the median internal fraud loss in manufacturing and production companies is $194,000.
Although companies can experience pilferage from customers, vendors, and other sources, employees account for the highest losses, when taking into account offenses such as fraudulent insurance claims, unauthorized time off, and theft of proprietary information. Crimes can be as simple as stealing company supplies or as complex as sophisticated financial statement fraud.
More specifically, fraud by managers and key executives generates the highest dollar losses because these employees are in a good position to falsify financial, credential, work-related, or test-related documents for personal gain. In today’s competitive environment, manufacturers need to have good systems in place to monitor and control all phases of their operations.
What can your manufacturing company do to prevent theft? The ACFE report found these measures to be effective:
Improve internal controls. For example, do not allow the same employee to keep books, collect funds, write checks and reconcile bank accounts. Arrange for monthly bank statements to be delivered unopened to the company owner, who should review them for unusual transactions, such as declining deposits and checks to unfamiliar parties. If your accounting functions are in the hands of one or two people, your business is at a higher risk of experiencing fraud. Outsourcing your accounting reduces this risk and allows for better internal controls. Your outsourced accountant should be able to identify problems, flag errors, and notify you of any inconsistencies.
Conduct background checks on new employees.
Arrange for fraud audits by Smith Schafer or an internal audit department. We can conduct regular independent internal control studies of cash accounts, bank statements, and other items to detect criminal activity. Surprise audits are an effective, yet underutilized, tool in the fight against fraud.
Be willing to prosecute perpetrators. Some organizations take no legal action because they are afraid of bad publicity, reached a private settlement, wanted closure, or considered internal punishment sufficient.
Provide ethics training for employees. Educate staff members about the possible sources of fraud and consequences, such as the loss of jobs, raises, and profits.
Institute anonymous fraud reporting mechanisms, such as hotlines. Fraud is commonly discovered through tips from employees, vendors, customers, or other sources. These people are frequently in a position to see violations of company policies or excessive personal spending by colleagues.
Install workplace surveillance devices. For example, a video camera monitoring a loading dock where theft is suspected.
Look for behavioral red flags including the perpetrator living beyond his or her means and having financial difficulties. They can also involve an unwillingness to share duties, a “wheeler-dealer” attitude, divorce or family issues, addiction problems, refusal to take vacations, and an unusually close association with vendors or customers.
Take a zero-tolerance stand on fraud. With a few basic procedures in place, internal business theft can be significantly reduced — or even eliminated — so your manufacturing company can flourish. Integrating internal controls into a manufacturing company’s processes does not need to mean severely increasing the overhead charges. Small tasks can be introduced to limit risk and use minimal time.
Questions on how to improve your company’s internal controls?
Let’s start the conversation. Contact us today to schedule a free 30-minute consultation with one of our industry experts.