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Measuring, Managing and Creating Value: A Framework for Accountants Serving Privately Held Companies

Measuring, Managing and Creating Value: A Framework for Accountants Serving Privately Held Companies

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Tax and accounting professionals consistently express a desire to move from commoditized compliance services like tax return preparation to higher-value advisory services. But they often lack the expertise, tools, and other supporting materials required to deliver a structured engagement that their client will perceive as valuable (and by extension, billable for the firm). This is a lost opportunity, particularly for practitioners who may already be providing ad hoc advisory on areas outside of tax or accounting compliance while acting as an “external CFO.”

The need for private companies to maximize their valuation in financing discussions with lenders, or with potential acquirors, is expected to grow in coming months as businesses rebuild in the wake of the current health crises and subsequent financial downturn.

Measuring, Managing, and Creating Value: A Framework for Accountants Serving Privately Held Companies will:

  • Provide organized guidance to help tax and accounting professionals expand their advisory services in the area of business valuation, and assist them in delivering a structured, consistent customer experience that will clearly have value in the eyes of their clients.
  • Scale tax and accounting professionals’ business by allowing skill building with the goal of confidently delegating advisory engagements across their entire staff, including less experienced associates.

Written with sharp attention paid to the unique and often difficult aspects associated with measuring and managing value of private companies, Measuring, Managing, and Creating Value explains the steps involved between improving performance and adding equity value. Based on the premise that generating cash flow available to owners of an entity is key to creating equity value, the publication will (1) identify and explain the main company-specific operating and financial attributes, including the risks of uncertain returns, that a prospective acquirer would take into account in setting a purchase price, (2) provide an organized framework for measuring value, and (3) provide a basis for establishing a workable financial management plan that has as its goal the increase in equity value.

Measuring, Managing, and Creating Value is divided into the following seven main sections:

  • Section I, A Brief Overview of Valuation Theory
  • Section II, Company-Specific Risk Factors and the Composite Discount Rate
  • Section III, The Components of Free Cash Flow to Equity
  • Section IV, Measuring Value Creation
  • Section V, Identifying Areas for Improvement to Create Value and Techniques for Implementation
  • Section VI, Preparing and Presenting Projected GAAP-Based Financial Statements and Projected FCFE
  • Section VII, Applying the Framework in the Midst (or Aftermath) of the COVID-19 Pandemic

Measuring, Managing, and Creating Value was created by Allan Afterman, CPA, Ph.D., preeminent author of several prominent Checkpoint publications, including GAAP Practice Manual, Accounting and Auditing Disclosure Manual, and Handbook of SEC Accounting and Disclosure.

  • Introduction
  • List of Computational Examples

Section I: A Brief Overview of Valuation Theory

  • Introduction
  • Valuing an Equity Interest
  • Projecting Future FCFE
  • Choosing the Discount Rate
  • Applying Valuation Theory
    • The Reasonableness of the Assumed Constant Growth Rate
    • Application of the Projected FCFE Approach in a Public Company Setting
    • Understanding the Critical Role of Estimates and Judgments
  • The Use of Valuation Multiples
  • A Variation of Free Cash Flow to Estimate Company Value
  • Key Takeaways

Section II: Company-Specific Risk Factors and the Composite Discount Rate

  • Introduction
  • Risk Premiums in General
  • Composition of an Entity’s Risk Profile
  • The Measurement of Operating Risk
  • The Measurement of Financial Risk
  • The Impact of Leases on Operating and Financial Leverage
  • The Impact of Capitalized Interest on Operating and Financial Leverage
  • The Impact of Accretion on an Asset Retirement Obligation and Other Liabilities and Assets
  • The Impact of Research and Development (R&D) Costs on Operating and Financial Risks
  • Consolidated Statements, Combined Statements, and the Impact of a Noncontrolling Interest
  • The Measurement Period
  • Evaluating a Company’s Operating Risk
  • Evaluating a Company’s Financial Risk
  • The Integrated Risk Evaluation
    • Using the Matrix for a Hypothetical Debt Rating
    • Other Approaches for Developing a Hypothetical Bond Rating
    • The Use of Historical Amounts to Measure Risk
  • Components of the Composite Discount Rate – the Link to Beta
  • A Brief Discussion of the Other Components of the Composite Discount Rate
    • The Risk-Free Rate
    • The Anticipated Rate of Inflation
    • The Equity Risk Premium
    • The Illiquidity Risk Premium
  • Key Takeaways

Section III: The Components of Free Cash Flow to Equity (FCFE)

  • Introduction
  • Individual Components of Free Cash Flow to Equity (FCFE)
    • The Effects of the New Revenue Recognition Requirements
    • The Effects of Other Comprehensive Income
    • The Effects of Capitalized Interest
    • Changes in Operating Working Capital
    • Capital Expenditures
    • Debt Principal Payments
    • The Effects of Business Combinations
    • The Effects of a Noncontrolling Interest
    • The Effects of Foreign Currency Exchange Rates
  • Computing FCFE Before Adjustments
    • Income Tax Effects of Adjustments
    • A Further Word About Adjustments
  • Key Takeaways

Section IV: Measuring Value Creation

  • Introduction
  • The Measurement of Value Added
    • The Value-Added Measurement Period
  • Setting the Composite Discount Rate
    • Changes in the Composite Discount Rate over Time
  • Measuring Value Drivers – the Components and Subcomponents of FCFE
    • Operating Income
    • Measuring Margins – Operating Effectiveness
    • Measuring Turnover Rates – Operating Efficiency
  • Key Takeaways

Section V: Identifying Areas for Improvement to Create Value and Techniques for Implementation

  • Introduction
  • The Disaggregation of Value Drivers
  • Operating Cash Flow (OCF)
    • Revenue
    • Gross Profit Margin
    • Operating Expense Margin
    • Retirement Benefits
    • Effective Income Tax Rate
  • Working Capital Levels
    • Accounts Receivable
    • Inventory
    • Accounts Payable
  • Capital Expenditures
  • Debt Principal Payments
  • The Composite Discount Rate
    • Operating Risk
    • Revenue Volatility
    • Operating Earnings Volatility and Operating Leverage
    • Financial Risk
  • Information Risk and Voluntary Disclosures
  • Managing for Value
    • Growth Opportunities
  • Emphasizing the Accountant’s Role
  • Key Takeaways

Section VI: Preparing and Presenting Projected GAAP-Based Financial Statements and Projected FCFE

  • Introduction
  • General Preparation and Presentation Guidelines
    • Going Concern Disclosures
    • Projecting Income Tax Expense
  • Illustrative Projected GAAP-Based Statements
  • Significant Assumptions and Other Disclosures
  • Projecting FCFE
    • Constructive Capitalization of Operating Leases
    • Reclassification of Capitalized Interest
    • Reclassification of R&D Costs
  • Measuring Value Added
  • Key Takeaways
  • Section VII: Applying the Framework in the Midst (or Aftermath) of the COVID-19 Pandemic
  • Introduction
  • Analysis of Current and Expected Conditions
    • Sources of Information
  • Preparing GAAP-Based Projected Financial Statements
    • Scenario Analysis
    • Matters to Be Considered
    • The Impact of Going-Concern Issues
    • The Impact of force majeure Contract Provisions
    • The Explicit Forecast Period
    • Management’s Plans to Enhance Value
    • Revenue
    • Costs and Expenses
    • Accounts Receivable Balances
    • Inventory Balances
    • Accounts Payable Balances
    • Property and Equipment (P&E)
    • Short-Term and Long-Term Debt
    • The Projected Cash Flow Statement
    • Disclosure of Significant Assumptions
  • Projecting FCFE
  • The Composite Discount Rate
  • Estimating Terminal Value
  • Key Takeaways

Practice Aids

  • Appendix A: Glossary of Terms, Principal Formulas, and Constructs Used in the Guide
  • Appendix B: Voluntary Disclosures—Drafting Guidelines
  • Appendix C: Techniques for Creating Value—A Summary
  • Appendix D: Checklist for Applying the Framework

List of Computational Examples

Section I

  • Example 1—Applying Valuation Theory
  • Example 2—Computing the Weighted-Average Cost of Capital Rate

Section II

  • Example 1—Measuring Operating Earnings Volatility
  • Example 2—Measuring Revenue Volatility
  • Example 3—Measuring Operating Leverage
  • Example 4—Excess Revenue Volatility Due to Growth
  • Example 5—Measuring Financial Risk
  • Example 6—Constructive Capitalization of Operating Leases
  • Example 7—Financial Risk Ratios Adjusted for Capitalization of Operating Leases
  • Example 8—Beta and the Required Rate of Return
  • Section III
  • Example 1—Effect on FCFE from the Reclassification of R&D Costs
  • Example 2—Effect on FCFE of Constructive Capitalization of Operating Leases
  • Example 3—Preliminary Calculation of FCFE
  • Example 4—Computing Adjusted FCFE
  • Example 5—Computing Adjusted FCFE on an After-Tax Basis

Section IV

  • Example 1—Measuring Value Added from an Increase in FCFE in the Current Period
  • Example 2—Overall Value Added when FCFE for the Current Period Decreases
  • Example 3—Measuring Value Added over the Forecast Period
  • Example 4—Building the Composite Discount Rate
  • Example 5—The Disproportionate Impact of a Change in the Composite Discount Rate
  • Example 6—Adjustments to EBITDA
  • Example 7—Computation of Adjusted TOA

Section V

  • Example 1—Using NPV for a Purchase Decision
  • Example 2—Value Index Ranking of Alternative Proposals

Section VI

  • Example 1—The Preparation of Projected GAAP-Based Financial Statements
  • Example 2—Projecting FCFE for the Explicit Forecast Period

Section VII

  • Example 1—Application of the Probability-Weighted Average Approach
  • Example 2—Application of the Multistage Growth Model
  • Example 3—Updating the Discount Rate

DESCRIPTION

Tax and accounting professionals consistently express a desire to move from commoditized compliance services like tax return preparation to higher-value advisory services. But they often lack the expertise, tools, and other supporting materials required to deliver a structured engagement that their client will perceive as valuable (and by extension, billable for the firm). This is a lost opportunity, particularly for practitioners who may already be providing ad hoc advisory on areas outside of tax or accounting compliance while acting as an “external CFO.”

The need for private companies to maximize their valuation in financing discussions with lenders, or with potential acquirors, is expected to grow in coming months as businesses rebuild in the wake of the current health crises and subsequent financial downturn.

Measuring, Managing, and Creating Value: A Framework for Accountants Serving Privately Held Companies will:

  • Provide organized guidance to help tax and accounting professionals expand their advisory services in the area of business valuation, and assist them in delivering a structured, consistent customer experience that will clearly have value in the eyes of their clients.
  • Scale tax and accounting professionals’ business by allowing skill building with the goal of confidently delegating advisory engagements across their entire staff, including less experienced associates.

Written with sharp attention paid to the unique and often difficult aspects associated with measuring and managing value of private companies, Measuring, Managing, and Creating Value explains the steps involved between improving performance and adding equity value. Based on the premise that generating cash flow available to owners of an entity is key to creating equity value, the publication will (1) identify and explain the main company-specific operating and financial attributes, including the risks of uncertain returns, that a prospective acquirer would take into account in setting a purchase price, (2) provide an organized framework for measuring value, and (3) provide a basis for establishing a workable financial management plan that has as its goal the increase in equity value.

Measuring, Managing, and Creating Value is divided into the following seven main sections:

  • Section I, A Brief Overview of Valuation Theory
  • Section II, Company-Specific Risk Factors and the Composite Discount Rate
  • Section III, The Components of Free Cash Flow to Equity
  • Section IV, Measuring Value Creation
  • Section V, Identifying Areas for Improvement to Create Value and Techniques for Implementation
  • Section VI, Preparing and Presenting Projected GAAP-Based Financial Statements and Projected FCFE
  • Section VII, Applying the Framework in the Midst (or Aftermath) of the COVID-19 Pandemic

Measuring, Managing, and Creating Value was created by Allan Afterman, CPA, Ph.D., preeminent author of several prominent Checkpoint publications, including GAAP Practice Manual, Accounting and Auditing Disclosure Manual, and Handbook of SEC Accounting and Disclosure.

TABLE OF CONTENT

  • Introduction
  • List of Computational Examples

Section I: A Brief Overview of Valuation Theory

  • Introduction
  • Valuing an Equity Interest
  • Projecting Future FCFE
  • Choosing the Discount Rate
  • Applying Valuation Theory
    • The Reasonableness of the Assumed Constant Growth Rate
    • Application of the Projected FCFE Approach in a Public Company Setting
    • Understanding the Critical Role of Estimates and Judgments
  • The Use of Valuation Multiples
  • A Variation of Free Cash Flow to Estimate Company Value
  • Key Takeaways

Section II: Company-Specific Risk Factors and the Composite Discount Rate

  • Introduction
  • Risk Premiums in General
  • Composition of an Entity’s Risk Profile
  • The Measurement of Operating Risk
  • The Measurement of Financial Risk
  • The Impact of Leases on Operating and Financial Leverage
  • The Impact of Capitalized Interest on Operating and Financial Leverage
  • The Impact of Accretion on an Asset Retirement Obligation and Other Liabilities and Assets
  • The Impact of Research and Development (R&D) Costs on Operating and Financial Risks
  • Consolidated Statements, Combined Statements, and the Impact of a Noncontrolling Interest
  • The Measurement Period
  • Evaluating a Company’s Operating Risk
  • Evaluating a Company’s Financial Risk
  • The Integrated Risk Evaluation
    • Using the Matrix for a Hypothetical Debt Rating
    • Other Approaches for Developing a Hypothetical Bond Rating
    • The Use of Historical Amounts to Measure Risk
  • Components of the Composite Discount Rate – the Link to Beta
  • A Brief Discussion of the Other Components of the Composite Discount Rate
    • The Risk-Free Rate
    • The Anticipated Rate of Inflation
    • The Equity Risk Premium
    • The Illiquidity Risk Premium
  • Key Takeaways

Section III: The Components of Free Cash Flow to Equity (FCFE)

  • Introduction
  • Individual Components of Free Cash Flow to Equity (FCFE)
    • The Effects of the New Revenue Recognition Requirements
    • The Effects of Other Comprehensive Income
    • The Effects of Capitalized Interest
    • Changes in Operating Working Capital
    • Capital Expenditures
    • Debt Principal Payments
    • The Effects of Business Combinations
    • The Effects of a Noncontrolling Interest
    • The Effects of Foreign Currency Exchange Rates
  • Computing FCFE Before Adjustments
    • Income Tax Effects of Adjustments
    • A Further Word About Adjustments
  • Key Takeaways

Section IV: Measuring Value Creation

  • Introduction
  • The Measurement of Value Added
    • The Value-Added Measurement Period
  • Setting the Composite Discount Rate
    • Changes in the Composite Discount Rate over Time
  • Measuring Value Drivers – the Components and Subcomponents of FCFE
    • Operating Income
    • Measuring Margins – Operating Effectiveness
    • Measuring Turnover Rates – Operating Efficiency
  • Key Takeaways

Section V: Identifying Areas for Improvement to Create Value and Techniques for Implementation

  • Introduction
  • The Disaggregation of Value Drivers
  • Operating Cash Flow (OCF)
    • Revenue
    • Gross Profit Margin
    • Operating Expense Margin
    • Retirement Benefits
    • Effective Income Tax Rate
  • Working Capital Levels
    • Accounts Receivable
    • Inventory
    • Accounts Payable
  • Capital Expenditures
  • Debt Principal Payments
  • The Composite Discount Rate
    • Operating Risk
    • Revenue Volatility
    • Operating Earnings Volatility and Operating Leverage
    • Financial Risk
  • Information Risk and Voluntary Disclosures
  • Managing for Value
    • Growth Opportunities
  • Emphasizing the Accountant’s Role
  • Key Takeaways

Section VI: Preparing and Presenting Projected GAAP-Based Financial Statements and Projected FCFE

  • Introduction
  • General Preparation and Presentation Guidelines
    • Going Concern Disclosures
    • Projecting Income Tax Expense
  • Illustrative Projected GAAP-Based Statements
  • Significant Assumptions and Other Disclosures
  • Projecting FCFE
    • Constructive Capitalization of Operating Leases
    • Reclassification of Capitalized Interest
    • Reclassification of R&D Costs
  • Measuring Value Added
  • Key Takeaways
  • Section VII: Applying the Framework in the Midst (or Aftermath) of the COVID-19 Pandemic
  • Introduction
  • Analysis of Current and Expected Conditions
    • Sources of Information
  • Preparing GAAP-Based Projected Financial Statements
    • Scenario Analysis
    • Matters to Be Considered
    • The Impact of Going-Concern Issues
    • The Impact of force majeure Contract Provisions
    • The Explicit Forecast Period
    • Management’s Plans to Enhance Value
    • Revenue
    • Costs and Expenses
    • Accounts Receivable Balances
    • Inventory Balances
    • Accounts Payable Balances
    • Property and Equipment (P&E)
    • Short-Term and Long-Term Debt
    • The Projected Cash Flow Statement
    • Disclosure of Significant Assumptions
  • Projecting FCFE
  • The Composite Discount Rate
  • Estimating Terminal Value
  • Key Takeaways

Practice Aids

  • Appendix A: Glossary of Terms, Principal Formulas, and Constructs Used in the Guide
  • Appendix B: Voluntary Disclosures—Drafting Guidelines
  • Appendix C: Techniques for Creating Value—A Summary
  • Appendix D: Checklist for Applying the Framework

List of Computational Examples

Section I

  • Example 1—Applying Valuation Theory
  • Example 2—Computing the Weighted-Average Cost of Capital Rate

Section II

  • Example 1—Measuring Operating Earnings Volatility
  • Example 2—Measuring Revenue Volatility
  • Example 3—Measuring Operating Leverage
  • Example 4—Excess Revenue Volatility Due to Growth
  • Example 5—Measuring Financial Risk
  • Example 6—Constructive Capitalization of Operating Leases
  • Example 7—Financial Risk Ratios Adjusted for Capitalization of Operating Leases
  • Example 8—Beta and the Required Rate of Return
  • Section III
  • Example 1—Effect on FCFE from the Reclassification of R&D Costs
  • Example 2—Effect on FCFE of Constructive Capitalization of Operating Leases
  • Example 3—Preliminary Calculation of FCFE
  • Example 4—Computing Adjusted FCFE
  • Example 5—Computing Adjusted FCFE on an After-Tax Basis

Section IV

  • Example 1—Measuring Value Added from an Increase in FCFE in the Current Period
  • Example 2—Overall Value Added when FCFE for the Current Period Decreases
  • Example 3—Measuring Value Added over the Forecast Period
  • Example 4—Building the Composite Discount Rate
  • Example 5—The Disproportionate Impact of a Change in the Composite Discount Rate
  • Example 6—Adjustments to EBITDA
  • Example 7—Computation of Adjusted TOA

Section V

  • Example 1—Using NPV for a Purchase Decision
  • Example 2—Value Index Ranking of Alternative Proposals

Section VI

  • Example 1—The Preparation of Projected GAAP-Based Financial Statements
  • Example 2—Projecting FCFE for the Explicit Forecast Period

Section VII

  • Example 1—Application of the Probability-Weighted Average Approach
  • Example 2—Application of the Multistage Growth Model
  • Example 3—Updating the Discount Rate

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