Understanding of various factors. Whether you’re a buyer or a seller, knowing how to accurately assess the value of a practice is crucial for a successful transaction. Let’s delve into the methods and metrics that should be considered to ensure an accurate and unbiased valuation.
Understanding the valuation methods used for small accounting practices
There are several valuation methods commonly used in the industry, such as the discounted cash flow (DCF), market approach, and asset-based approach. Each has merits and drawbacks, often depending on the practice’s specific circumstances. For years, the industry used a simple one rand of turnover equals one rand for price, known as the traditional approach. While still relevant, it’s important to note that the landscape has changed due to technological advancements and shifts in productivity. The traditional valuation methodology has evolved. The most potent method today is the comparative market assessment (CMA). It compares the firm with similar ones, using empirical data and current market conditions to provide an accurate value.
Evaluating financial performance metrics and profitability indicators
Financial performance is a key indicator of a practice’s value. Metrics like revenue, EBITDA, seller’s discretionary earnings (SDE), and net profit margins should be scrutinised. Additionally, profitability indicators such as client revenue concentration and service line profitability can provide deeper insights into the financial health of the practice. You should analyse all the above and in a CMA you get a holistic view of the performance of a practice to underpin the valuation for it.
Assessing the value of client relationships and client retention rates
A practice’s client base is one of its most valuable assets. Assess the quality of client relationships by looking at retention rates, lifetime value, and the diversity of the client base. A high client retention rate often signals strong client relationships, which can add significant value to the practice. A spread across industries and geographical areas spreads the risk. Assessing the clients and determining the risk of them closing down tells you a lot about the practice.
Assessing cash flow, staff productivity, and debtors
Cash flow is the lifeblood of any business. Staff productivity metrics such as billable hours and revenue per employee can also provide valuable insights. Additionally, consider the practice’s debtor situation: a high amount of outstanding receivables could be a red flag. Higher than normal bad debt is another red flag. A firm with low indicators in areas like productivity, low billing and slow payers surely cannot be valued traditionally if compared to someone with great staff productivity, high margins, efficient technology and great payers.
Analysing market comparables and benchmarking against industry standards
Comparing the practice against similar businesses in the market can provide a realistic valuation range. Utilise industry benchmarks for metrics like revenue per client or profit margins to see how the practice stacks up against its peers. Fees charged for services and software used establish not only billing behaviours and competitiveness but also the technological position of the firm. Using empirical data from other firms you get a yardstick position about the firm’s performance.
Considering the impact of industry and market conditions on practice valuation
External factors like economic conditions, regulatory changes, and industry trends can significantly impact a practice’s value. Being aware of these factors and how they affect your specific practice is crucial for an accurate valuation. Deal structures offered by the industry change over time to ensure risk mitigation with specific deposits and warranties and address affordability with specific terms. The valuation should consider all this and also assign a What-If analysis to that.
Considering the Impact of a turnover warranty on the practice valuation
The industry standard is that a turnover warranty will be provided on the revenue. When a seller refuses to offer this, he wipes 70% of the value off the table and will ultimately pay the price for his unwillingness. The reality is that a warranty is essential, coupled with seller finance, to ensure the correct value is unlocked for the seller. This ensures a fair deal, and this significantly impacts the valuation.
Considering the impact of seller financing on practice valuation
Financial institutions focus on asset-based financing like car loans. However, getting a loan to buy clients is challenging: you can’t repossess a client. Seller financing changes the game, making a practice more appealing to buyers and affecting its valuation. If the seller finances part of the sale, it significantly boosts the practice’s value by lowering the entry barrier for potential buyers.
Seeking professional assistance to ensure an accurate and unbiased valuation
Given the complexities involved in valuing a small accounting practice, seeking professional advice, especially from someone with relevant industry data for a CMA like a specialist business broker, is highly recommended. Their expertise can provide an additional layer of accuracy in the valuation process.
Valuing a small accounting practice is a complex but crucial step in the buying or selling process. By understanding and carefully considering the various factors outlined above, you can arrive at a more accurate and fair valuation. Whether you’re a buyer or a seller, being well-informed is key to a successful transaction.
Feel free to reach out for further guidance or clarification on any of these aspects.
Louis Bruwer is an experienced and specialist business broker with a demonstrated history of business sales. www.bizxchange.co.za