Business valuation and economic outlook

It is axiomatic that no business operates in a vacuum. General industry conditions are perhaps the biggest part of systematic risk a company faces. The reason it is called systematic is that you cannot avoid it by diversifying your business investment. The entire economy is affected, so you have to ride out the rough spots as best you can.

Every time you see a business valuation report, the appraiser has made a set of assumptions about the economy going forward. In fact, professional valuation reports contain a section dealing with the economic conditions. This discussion forms the basis of earnings and expenses forecasts that you see further down in the report.

On occasion, you may run across the economic discussion that seems too lengthy or complicated. Indeed, what future holds is anyone’s guess. Looking into the future beyond a couple of years is fraught with potential errors. Overall market indicators such as the national or regional economic growth prospects are probably more important than tactical decisions made by the Federal Reserve.

Remember that historic performance is just that – a point in history. It will never be repeated so the economic conditions and business outlook will differ from years past. If your business appraisal dwells exclusively on the past, it is likely to miss significant developments that could substantially change your business prospects.

Business value is about risk and returns. As such, business valuation is a forward looking exercise. History is a guide, but accurate business valuation depends on how well you can envision what the business will be able to accomplish in the future.

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