Entries by James Cook

Understanding Goodwill

Understanding Goodwill

When determining the Goodwill of a business, it is important to understand the characteristics of the business and the different types of Goodwill that may exist.



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Tuesday, 29 September 2020

By James Cook

As noted in our previous article, when undertaking a business valuation, valuers are guided by common market practice and the valuation methodologies recommended in the ASIC Regulatory Guide 111.

When adopting the Capitalisation of Earnings Methodology, it is not uncommon for the calculation to deviate from the business’ net operational business assets. In circumstances where the value calculated under the Capitalisation of Earnings Methodology exceeds the net operational assets of the business, the excess or premium is typically referred to as the Goodwill component.

In many small businesses, Goodwill can represent a significant amount of a business’ value, however its intangible nature can lead to disagreement between parties.

When determining the Goodwill of a business, it is important to understand the different types of Goodwill that may exist in a business. Common types of Goodwill will include:

Personal Goodwill

Where the owners of the business have personal followings of clients such as professional services firms, this is typically attributable to Personal Goodwill.  The risk (which is typically built into any earnings multiple) is that when businesses are sold or key personnel exit the business, there is a risk that clients may also leave.

Values which are attributable to Personal Goodwill should be carefully considered by a valuer and have regard to the existence of restrictive covenants or guarantees that a vendor is willing to provide.

Corporate Goodwill

Corporate Goodwill will generally attach to the business independent of its owners and arises from having an established brand or reputation, key product lines or a loyal customer base.

Corporate Goodwill commonly exists with businesses in the wholesale and manufacturing industry where reliance on key business owners is less critical to client retention and the operations of the business.

Location Goodwill

Where businesses operate from strategically located premises, Goodwill can sometimes be attributable to Location Goodwill.

Businesses which possess Location Goodwill may include Aged Care Facilities, Motels and Childcare Centres, however when attributing some or all of the Goodwill of a business to its location, a valuer should have regard to the following risk factors that may have an effect on this assessment:

  • Length of time remaining under the current lease and the existence of options;
  • Any identifiable deterioration of the commercial value of the location such as a permanent diversion of traffic flows;
  • Any changes in regulations requiring an upgrade of the premises; or
  • Any difficulties posed by the landlord in effecting a transfer of the lease.

 Conclusion

The different types of Goodwill extend beyond those listed above and it is crucial that valuers properly consider the characteristics of the business being valued when undertaking their assessment.

For any specific or general business valuation queries, please get in touch with one of our qualified and experienced experts.


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Understanding Goodwill

When determining the Goodwill of a business, it is important to understand the characteristics of the business and the different types of Goodwill that may exist.


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Future-Proof Your Business: Strategic Restructuring Options for Business Owners

Future-Proof Your Business: Strategic Restructuring Options for Business Owners

The window of opportunity is slowly closing for directors to explore strategic restructuring options for their businesses



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Wednesday, 19 August 2020

By James Cook

With 25 September 2020 just around the corner, it is now more important than ever that business owners pause and take stock to carefully consider what the next 12 months of trading might look like for their business.

In March 2020, the Federal Government introduced the Coronavirus Economic Response Package Omnibus Act 2020 (Cth) which was designed to provide temporary relief to businesses and stimulate economic activity. Among the incentives and temporary measures initiated by the Federal Government, many business owners have subsequently been able to:

    • Defer repayments owing on business loans, mortgages and other finance facilities;
    • Access rent waivers and rent deferrals from landlords;
    • Access significant cash flow stimulus and wage subsidies;
    • Access six (6) months of stimulus under the Jobkeeper program;
    • Obtain temporary relief and an extension to comply with statutory demands from 21 days to six (6) months; and
    • Take advantage of the temporary easing of insolvent trading laws.

Whilst these temporary measures have had their desired effect, this has however, created an artificial economic environment for many businesses, which has left many business owners awash with cash and a false sense of business performance.

As the temporary relief begins to wind back from 25 September 2020, the months of August and September should serve as an opportune time for business owners to take stock and ensure they are preparing their business for the next phase of the recovery cycle.

EARLY INTERVENTION IS KEY

As businesses slowly begin to be weaned off the Federal Government’s various stimulus packages, it is critical that business owners now use the comings months to:

    • Revisit historical performance of the business and consider the financial impacts from the withdrawal of any previously relied upon stimulus;
    • Carefully assess the business’ financial position and identify the levers and key drivers of financial performance (i.e. billable hours, inventory levels, occupancy rates);
    • Revisit the business’ forecasts and cash flow assumptions and ensure the revised projections are reflective of the current operating structure of the business;
    • Explore profit optimisation strategies and consider resizing the cost base of the business (where practicable);
    • Develop liquidity forecasts and investigate cash flow improvement strategies available to the business (i.e. changes in trading terms);
    • Conduct customer segmentation and profitability analysis and ensure the business remains focussed on its core target market; and
    • Develop strategies to maximise revenue, streamline processes and optimise the cost structure of the business.

Businesses facing challenging operating conditions should seek prompt, specialist advice to reduce the risks and consequences of financial failure and increase the options available to the business.

WHERE GT ADVISORY & CONSULTING CAN ASSIST

During times of business distress, we work alongside directors and management teams to manage the financial pressures on the organisation and develop strategies that maximise value for stakeholders.

Read more here to learn about how GT Advisory & Consulting can assist.


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Understanding Goodwill

When determining the Goodwill of a business, it is important to understand the characteristics of the business and the different types of Goodwill that may exist.


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What are Surplus Assets and Liabilities in business valuation?

What are Surplus Assets and Liabilities in business valuation?

Surplus Assets are represented by any assets that are held by a business that are not core to its underlying operations and do not support the business in any way.



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Tuesday, 4 August 2020

By James Cook

When determining the equity value of a company, a valuer will typically test for the existence of Surplus Assets and Liabilities held by the company.

Surplus Assets are represented by any assets that are held by a business that are not core to its underlying operations and do not support the business in any way. Surplus Assets will typically include:

  • Property (such as the premises) that might be held by the business which would usually be valued separately and added to the enterprise value of the business.
  • Obsolete assets that may have been originally acquired for the business but have since been replaced or have become surplus to the operation of the business.
  • Personal use assets that are not necessary to the running of the business, such as motor vehicles or boats.
  • Surplus working capital such as excess inventory and cash.
  • Loans to directors or other related parties.
  • Investments made by the business that are not core to its underlying operations.

Similarly, when determining the equity value of a company, a valuer will also need to take into account the liabilities of the business. Liabilities that are typically considered and deducted from the enterprise value of the business include:

  • Loans owing to related parties.
  • Provisions for employee entitlements such as long service leave.
  • Any off-balance sheet liabilities such as contingent liabilities that may arise from pending litigation.

Every business that is valued under the capitalisation of future maintainable earnings method should be assessed for surplus assets and liabilities.

The impact of surplus assets and liabilities should be considered at two levels:

Level 1

Where the entity as a whole is being valued, the value of the surplus assets and liabilities should be added/deducted from the capitalisation of future maintainable earnings calculation to determine the entity value.

If the valuation is for the business assets, surplus asset or liability value is only relevant if the assets or liabilities to be included in the class of assets, form part of the valuation.

Level 2

Consideration also needs to be given to whether the surplus assets or liabilities have created holding costs for the business. Where these holding costs are identified, they should be quantified and adjusted out of the calculation of Future Maintainable Earnings.


Latest News & Insights


Understanding Goodwill

When determining the Goodwill of a business, it is important to understand the characteristics of the business and the different types of Goodwill that may exist.


Read More »

Valuation Methodologies: The Capitalisation of Earnings methodology

Valuation Methodologies: The Capitalisation of Earnings methodology

The capitalisation of earnings method is a commonly used valuation methodology that involves determining a future maintainable earnings figure for a business and multiplying that figure by an appropriate capitalisation multiple.



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Tuesday, 4 August 2020

By James Cook

When undertaking a business valuation, valuers are guided by common market practice and the valuation methodologies recommended in the ASIC Regulatory Guide 111.

There are a number of valuation methods which can be used to value a business and some of the more common methods include:

  1. The discounted cash flow method (Income-based Approach)
  2. The capitalisation of future maintainable earnings methods (Income-based Approach)
  3. Asset based methods (Asset-based Approach)
  4. Industry specific rules of thumb (Market-based Approach)

Each of these methods is appropriate in certain circumstances and often, more than one approach is applied at least as a secondary cross-check to a primary method. The choice of methods depends on factors such as the nature of the business being valued, the return on the assets employed in the business, the valuation methodologies usually applied to value such businesses and the availability of the required information.

The selection of an appropriate valuation method to estimate fair market value should be guided by the actual practices adopted by potential acquirers of the business involved.

In the discussion which follows, we outline the Capitalisation of Earnings methodology.

Capitalisation of Earnings methodology: Explained

The capitalisation of earnings method is a commonly used valuation methodology that involves determining a future maintainable earnings figure for a business and multiplying that figure by an appropriate capitalisation multiple. This methodology is generally considered a short form of a discounted cash flow, where a single representative earnings figure is capitalised, rather than a stream of individual cash flows being discounted. The capitalisation of earnings methodology typically involves the determination of:

  1. A level of Future Maintainable Earnings;
  2. An appropriate capitalisation rate or multiple;
  3. Surplus assets and liabilities; and
  4. Net borrowings.

Determining Future Maintainable Earnings:

The Future Maintainable Earnings figure is typically determined by a valuer having regard to historical financial performance and is intended to be earnings which the business can be reasonably expected to achieve.

In determining the appropriate future maintainable earnings figure, a valuer should however consider historical transactions which have involved:

  • Expenses associated with the capital structure and financing costs of the business;
  • Non-arms-length revenue or expenses;
  • Revenue or expenses generated or associated with, redundant assets or assets which are not core to the operations of the business;
  • Owner-related expenses; and
  • Non-recurring, one-off expenses.

Appropriate capitalisation rate or multiple

A multiple can be applied to any of the following measures of earnings:

Revenue – most commonly used for businesses that do not make a positive EBITDA or as a cross-check of a valuation conclusion derived using another method.
EBITDA – most appropriate where depreciation distorts earnings, for example, in a business that has a significant level of depreciating assets but little ongoing capital expenditure requirement.
EBITA – in most costs, EBITA will be more reliable than EBITDA as it takes account of the capital intensity of the business.
EBIT – whilst commonly used in practice, multiples of EBITA can be more reliable as it removes the impact of amortisation which is a non-cash accounting entry that does not reflect a need for future capital investment (unlike depreciation).
NPAT – relevant in valuing businesses where interest is a major part of the overall earnings of the group (e.g. financial services business such as banks).

Multiples of EBITDA, EBITA and EBIT are commonly used to value whole businesses for acquisition purposes where gearing is in the control of the acquirer. In contrast, NPAT (or P/E) multiples are often used for valuing minority interests in a company.

The multiple selected to apply to maintainable earnings reflects expectations about future growth, risk and the time value of money all wrapped up in a single number.

Surplus assets and liabilities

Every business valued under the capitalisation of future maintainable earnings method should be assessed for surplus assets and liabilities. Surplus assets are those assets that are not essential for the operation of the business and will typically include property, non-core investments, excess working capital and loans to private businesses or related parties.

When undertaking this exercise, the impact of surplus assets and liabilities should be considered at two levels:

Level 1
Where the entity as a whole is being valued, the value of the surplus assets and liabilities should be added/deducted from the capitalisation of future maintainable earnings calculation to determine the entity value.

If the valuation is for the business assets, surplus asset or liability value is only relevant if the assets or liabilities to be included in the class of assets, form part of the valuation.

Level 2
Consideration also needs to be given to whether the surplus assets or liabilities have created holding costs for the business. Where these holding costs are identified, they should be quantified and adjusted out of the calculation of Future Maintainable Earnings.

Conclusion: When to use the Capitalisation of Earnings methodology

The capitalisation of earnings method is widely used in practice. It is particularly appropriate for valuing companies with a relatively stable historical earnings pattern which is expected to continue. This method is less appropriate for valuing companies or assets if:

  • There are no suitable listed company transaction benchmarks for comparison;
  • The asset has a limited life (such as a contract, patent, royalty stream);
  • Future earnings or cash flow are expected to be volatile; or
  • There are negative earnings, or the earnings of a business are insufficient to justify a value exceeding the value of the underlying net assets.

For any specific or general business valuation queries, please get in touch with one of our qualified and experienced experts.


Latest News & Insights


Understanding Goodwill

When determining the Goodwill of a business, it is important to understand the characteristics of the business and the different types of Goodwill that may exist.


Read More »

Directors’ duties under the temporary COVID-19 measures

Directors’ duties under the temporary COVID-19 measures

Temporary relief from personal liability for insolvent trading will apply with respect to debts incurred in the ordinary course of the company’s business.



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Monday, 20 July 2020

By James Cook

An Overview of Directors’ Duties

Directors and officers of companies are subject to a number of statutory and general law obligations, including:

  • Care and diligence: to exercise their powers and discharge their duties with due care, skill and diligence;
  • Good faith and proper purpose: to act in good faith in the best interests of the company, and for a proper purpose;
  • Not to misuse information or position: not to improperly use or profit from their position or information obtained as a director to gain an advantage for themselves or someone else, or to cause detriment to the Company;
  • Avoiding conflicts of interest or duty: to avoid conflicts between the Director’s personal interests and the company’s interests, and between the Director’s duties to the Company and the Director’s duties to anyone else;
  • Financial information: to take reasonable steps to ensure that a company complies with its obligations in the Corporations Act 2001 (Cth) (“the Corporations Act”) related to the keeping of financial records and financial reporting); and
  • Insolvent trading: to ensure that a company does not trade whilst insolvent or where they suspect it might be insolvent.

Temporary safe harbour from insolvent trading

In an effort to create a safety net to lessen the threat of actions that could unnecessarily push companies into insolvency and force the winding up of otherwise profitable businesses, the Australian Government introduced the Coronavirus Economic Response Package Omnibus Act 2020 (“the CERPO Act”) which is designed to provide directors of corporations with temporary easing of insolvent trading laws.

In line with the CERPO Act, section 588GAAA has now been introduced into the Corporations Act and provides directors with a new safe harbour defence to rely on for the incurring of debts whilst trading insolvent.

Directors and their advisors however, should bear in mind that this relief will only apply to debts incurred in the ordinary course of the company’s business and during the period 25 March 2020 to 24 September 2020 and importantly, this does not relieve directors’ of the balance of their fiduciary duties under the Corporations Act.

Where directors seek to rely on section 588GAAA as a defence to trading a company whilst insolvent, they will need to be able to point to a continuing viable business that is supported by appropriate forecasts and/or advice from appropriately qualified professionals.

Continuing to trade an unviable business without a proper plan or strategy exposes directors to personal liability under the relevant statutory provisions of the Corporations Act so it is critical that directors make themselves aware of these provisions and actively manage the company’s financial position on a regular basis.

The safe harbour provisions in section 588GA will remain an important consideration, mirroring, if possible, this new and temporary safe harbour. Accordingly, if the business is insolvent, or likely to become insolvent at any point of time, directors should still ensure they satisfy or explain why they are not able to satisfy the preconditions to safe harbour protections, including to record the strategy in a written plan.

25 September 2020 and beyond

Whilst the Treasury Amendment Bill does contemplate further possible extensions to this timeframe, directors and their advisors should be proactively monitoring the company’s financial position and seek advice from appropriately qualified professionals if the company’s outlook changes.

Early intervention is the key to maximising value for stakeholders and giving the business its best chance of survival.


Latest News & Insights


Understanding Goodwill

When determining the Goodwill of a business, it is important to understand the characteristics of the business and the different types of Goodwill that may exist.


Read More »