Going concern value
This article is about going concern value and a few subjects around business valuation.
Having already written an article about how to value a start up business, I thought I’d explore business valuation in more detail, but focus on going concern value in particular and how the ‘going concern status‘ affects its value..
Main sections of this article on going concern value are:
- What is the going concern definition
- Going concern value vs liquidation value
- Understanding going concern accounting
- Selling a business as a going concern
- Going concern valuation method
- Transfer of going concern
What is the going concern definition…
Broadly speaking going concern is referring to a business operating at a profit, which is expected to trade for the foreseeable future. The foreseeable future in this regard is usually considered over a 12 month period. This means that a business is declaring to the outside would, i.e. to its customers and suppliers, that it is going to continue to run its activities for the next year.
If a business is regarded as a going concern it is viewed in a positive way. Whereas if a business is not seen as a going concern, then this brings with it negative connotations.
A going concern business will usually have a certain amount of goodwill in its valuation. The amount of goodwill in the value of the business will depend on a number of things.
These include the level of profits and the length of time the business has been in operation. Another factor affecting value will be the sector the business trades in. Also, how dependent it is on the owner or the business. See below for more valuation factors.
If a business isn’t a going concern, business management will need to answer questions, like:
- “How long will the company continue to trade?“
- “Should the directors of the business appoint either receivers or liquidators.”
- “What assets does the business have that could be sold?“
- “What is the value of those assets and is there a ‘fire-sale’ situation.”
- “Are the options to save the business through loans or further investment?“
- “Can any of the existing debt be restructured?“
- “What cost-cutting would make a difference to save money?“
Going concern value definition…
Looking at the going concern value definition specifically, this is the value of a business which is likely to trade for at least the next 12 months. The situation where the going concern value might be used is where a business is being valued for sale.
Going concern value vs liquidation value…
This leads on to a comparison between going concern value vs liquidation value. The going concern value and liquidation value are two totally different values.
Going concern valuation…
The going concern value of a business will include assets at a fair market value. This means that assets are valued at a fair price. This price is what the market will pay for the asset, given enough time to sell it.
This means a value at a price with a “willing seller and a willing buyer” at a price which is not forced due to adverse conditions.
As already mentioned, if we look at the overall business valuation, this would usually include an amount for goodwill. Goodwill is the difference between what a person is prepared to pay for a business, less the fair value of the underlying assets.
On the other side of this coin is liquidation value. Assets valued in a liquidation situation tend to be valued at under market value. The reason for this is that they tend to be sold in a ‘forced situation.’
Liquidators tend to use auctions to sell-off business assets. Auctions tend to sell assets at whatever the auctioneer can get. Assets are sold at the bid price is on the day. This is except where a reserve is placed on the assets placed in the auction.
However, liquidators are only concerned with getting assets sold, in order to pay-off as much of the business debt as possible. Therefore, they are not likely to place reserves on assets place in auctions.
A business in liquidation is not a going concern business. It will therefore not have a going concern value. The value of a company in liquidation will be whatever the liquidator is able to get for the assets in a fire-sale situation.
The other comparison is going concern value vs receivership value. If a business has cash flow difficulties, for example it finds itself “over-trading“, then calling in the liquidator may not be the answer.
Instead the directors should discuss the situation with a receiver instead.
A receiver looks at a business in a different way to a liquidator. Instead of looking to wind the company up and sell off the assets at auction, a receiver will be looking for ways to save the business instead.
In this case the receiver will be seeking an investors to buy the business as a going concern. As regards the value of a business in receivership, this will depended on a number of factors. The value will not be the full going concern value, but it is likely to be higher than the liquidation value.
Ultimately, the value of the business, which would still be regarded as a going concern, would be whatever value the investor is will to pay it for.
In many cases we see businesses like this being sold for £1. However, the person that buys the business usually takes over the underlying liabilities. Normally, the investor will need to inject capital into the business in order for it to survive, which is why the value would be suppressed from a full valuation.
Understanding going concern accounting…
Going concern accounting means that the financial statements of the business are prepared on a going concern basis. This means that the assets included on the balance sheet will be included at a fair market value. A note to the financial statements to the effect that the accounts have been prepared on the going concern basis will be made by management.
In accounting terms, “going concern” refers to a company’s ability to continue functioning as a business entity into the foreseeable future. If a company is not considered a going concern, then it is required to disclose this fact in its financial statements or if there are any factors that may put the company’s status as a going concern in doubt.
With all companies it is the directors responsibility to review the business and the accounts. They must decide whether or not the accounts should be prepared on a going concern basis.
Going concern in auditing…
Where a company requires an audit, the auditors will want to satisfy themselves that the business is a going concern. A part of the audit process is to look at post balance sheet events. The auditors will be on the look out for any events that might affect the ability of the business to continue as a going concern.
If the auditors discover an event, they will have to review the potential impact on the business to continue to trade as a going concern.
Auditors don’t only look at post balance sheet events to consider if the business is a going concern. They also look at whether the company is able to meet its liabilities, as and when they fall due. In other words; is the company solvent.
A company that isn’t able to meet its obligations, is potential insolvent and the directors will need to take advice. If this is the case the business is potentially no longer a going concern too.
Auditor discussion with directors about going concern…
The action of the auditors based upon information that comes to light would include speaking with the directors of the business.
If these discussions are not satisfactory, and the auditors still believe that the business will not continue as a going concern, they made need to consider qualifying the audit report on those grounds.
The auditors will need to think about this very carefully. A qualification along these lines, or a change in the way the accounts are prepared, i.e. the accounts are not prepared on a going concern basis, will be put an already vulnerable business into an even more precarious situation.
Any one looking at accounts with this type of audit qualification or if the accounts are not prepared on a going concern basis would give cause for concern. In many cases it would send most customers or suppliers running for the hills.
If the business wasn’t already doomed, it would be after this.
Selling a business as a going concern…
If you are selling your business as a going concern, you’re selling the business which has an on-going trading activity.
If you are selling your business as a going concern, rather than selling the individual assets of a business, you’ll need to be able to demonstrate to potential buyers that they’ll be able to walk into your business and take over without any major problems from day-one.
Buying a business as a going concern…
On the converse side of selling a business as a going concern is buying a business as a going concern.
A buyer of a business will be interested in the “going concern value” of the business. The going concern value is usually higher than the individual assets underlying the business. If the business is profitable and has good cash flow the value is likely to include an element of goodwill.
The amount paid for goodwill will ultimately be dependent on negotiations between the buyer and the vendor.
Lending against going concern value…
The person buying a business may be looking to borrow from a bank. There are difficulties in getting lending against going concern value. At the lower end of the scale banks tend not to lend against the going concern value of a business.
Banks prefer to have an asset which provides more lending security, like property.
The problem with lending against going concern value is that the value is too subjective. Also, the going concern value is much more dependent upon the person in charge of the business. Whereas property is much easier to value and the value of property tends to be more stable in the longer term.
Going concern valuation method…
The going concern value of a business is the value of a company on the assumption that it will continue to operate for the foreseeable future. This is in contrast to liquidation value, which assumes the company is going out of business in the near future. The best going concern valuation method and one used by most accountants is the profit multiple.
The value in this case will be affected by a number of factors:
- The level of profits reported in the profit and loss account.
- The profit used in the valuation, e.g. net profit, EBITDA, EBIT and so on. Many times EBITDA is used for valuation.
- Whether the profits increasing or decreasing will affect value.
- How much is the business is dependent on the business owner.
- Whether the business is dependent upon a small number of clients or perhaps one very large client. If the company has a large percentage, i.e. greater than 20% with one customer, the business value will be adversely affected.
- The value is industry dependent.
- The length of time the business has been in operation.
- How soon the owner is looking to sell the business. The quicker the vendor is looking to sell the business, the lower the valuation.
By taking all of the above factors in to account this will lead to a businesses value. Take the appropriate profit and multiply this profit by an agreed number – an average multiple for this is three-times profits. But there are so many factors to consider. In the end however, the final value (or what is paid for a business) is down to the negotiating parties.
Transfer of going concern…
Businesses, or certainly the trade within a business, can be transferred as a going concern. The value of a business transferred as a going concern would be at a value using the same techniques discussed above.
In the case where a business is transferred as a going concern, this can be scrutinised by government tax departments like HMRC. For example a valuation for VAT purposes is usually where the business is transferred as a going concern. If this is the case VAT is not normally applied to the transferred assets.
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