A business is said to be in financial distress when a business cannot generate sufficient or any profit and the business is unable to meet or pay its financial obligations. This is generally caused by several factors such as high fixed costs, a large pool of illiquid assets or revenues that are sensitive to economic downturns. In these uncertain times it is crucial to analyse certain aspects of a business when undertaking a valuation of a distressed business.
Declines in Revenue
When undertaking a valuation of a distressed business careful consideration should be taken in analysing declines in revenue and what has caused these declines. Firstly you should do a comparison of the revenue trend in the six months prior to the valuation and compare these to the same period in the prior two years to understand the scale of any reduction in revenue and understand what is the cause behind any reduction in revenue. Has the reduction been caused by factors outside of the businesses control such as a contraction in the economy? Is the business affected by seasonality? Has the business lost market share? Has the business lost one of its major customers? Understanding what the decline in revenue is due to will help with understanding understand if the revenue risk is temporary or is due to factors outside of the businesses control.
Aged Debtors
When undertaking a valuation of a distressed business it is imperative to undertake a careful analysis of the aged debtors balance and understand what the trends are around customers payments. If there are any customers who usually pay within payment terms but are now not meeting their payment obligations this may be due to the customer having cash flow issues and struggling to pay their debts as and when they fall due. If a large customer has stopped accruing a payable balance this may be due to the customer no longer using the services or products of the business which may have a long term impact on the profitability and viability of the business.
Expenses
When undertaking a valuation of a distressed business you would expect all of the variable expenses of the business such as wages and cost of sales to reduce in line with the reduction in revenue. If the wage expenses are at the same level before a reduction in revenue, then the business may have additional staff that are not being utilised and may be additional to the requirements of the business. If the cost of sales expense has not reduced in line with the revenue, then the business may be ordering materials in excess of the current requirements. Careful consideration should be taken when analysing the expense trends over the period of analysis.
When valuing a distressed business, it is imperative to look at revenue and expense trends as these can tell a story of how and why the business is in its current distressed state.
At Groves & Partners, our expert team of business valuers have experience conducting valuations on distressed businesses. If you require advice on minority shareholding valuations, please contact us on 1300 892 717 (International +61 2 7208 7970) or email info@groves.com.au.