It comes as no surprise that increased costs as a result of rampant inflation can impact a company’s value. However, the Federal Reserve’s attempts to keep rising costs under control has a compounding negative impact on your business’ value.
The immediate problem facing business owners in today’s climate is rampant inflation because of numerous factors including governmental economic stimulus, a nationwide workforce reduction and supply chain shortages in many industries. The increase in costs impacts cash flows of a company which naturally leads to a decrease in business value. However, some companies are capable to pass these costs directly to the consumer and see continued profit growth despite rising costs. Despite these companies’ successes in weathering difficult times, these companies may still see a decrease in overall value as a result of increased borrowing costs.
There are three main approaches in business valuation, the market approach, the asset approach, and the income approach. In all cases, rising interest rates will lead to a potentially lower valuation through an investor’s increased borrowing costs. However, the primary method impacted is the income method. A business purchased for their profits and cash flows will be more heavily impacted by the costs of financing as opposed to business purchased for their assets. When investors borrow in order to invest in a company, they must consider both the risk of their investments and their borrowing costs into the future. As a result of the recent increases in short-term borrowing, those using any sort of financing to purchase companies must lower their expected future cash flows of the company, which lowers the current value of the company.
What does this mean for business owners? If you do not plan on transitioning your business in the near future, you can ignore many of the short-term factors that currently impact your business value, especially if you are remaining profitable despite the continual rising costs. However, if you are looking to transition the company to employees or family members at an advantageous price, now could be a solid time to do so. The current increase in borrowing rates and loss in business value make it a prime opportunity to gift your business to others as it will minimize your tax obligations in the long-term.
Regardless of your situation, HBE’s team of dedicated valuation professionals is here to help. Leveraging our depth of resources in cross-disciplinary business planning, our aim is to leave you feeling confident that you have a clear picture of value and a solid follow-up strategy in place so you can achieve your aspirations. For more information on our Valuation Specialty Team and service offerings, please click here.