Assets and Liabilities the Balance Sheet Does Not Show (Part 1 of 2)

Assets and Liabilities the Balance Sheet Does Not Show (Part 1 of 2)

The following was written by David K. F. Brown, a veteran business broker. It is reprinted with permission from the newsletter of the Institute of Certified Business Counselors, The Certified Business Counselor


 

As a practicing business appraiser, counselor and intermediary, I have studied literally thousands of balance sheets over the years in order to analyze the health and value of a business. In doing so, I always come up short of what the real-life value or health is; there always seems to be an X-Factor missing.

Yes, one can arrive at reasonable market values for the hard assets, and one can arrive at approximate values for goodwill using textbook approaches. However, the two combined still do not tell the whole story. It’s kind of like having competent physicians prod and probe you from one end to the other and declaring there is nothing wrong with you. Yet, you know that something is not quite right. After all, haven’t you come to know your body pretty well for having lived in it these many years!

One can even go to great lengths in studying market predictions, market share, location value, demand fluctuations, and a whole host of other factors that may color a final valuation conclusion, but the pulse of the business may not yet be felt.

Now that I have mentioned some of what that X-Factor is not, it is time to bring into focus what it is. Let me give you an example before the open container law came into effect in my city, I used to use the Labatts Method (named after Labatt’s Ale from Canada) of business valuation. Having completed my report for the shareholders, but not yet having it prepared in final report form, I would sit across the street from the business in question and would ask myself this question: ‘Would I pay that price (my tentative value conclusion) for this business?’

My thoughts would include how I was treated when the clerk waited on me, the first impression I had in visiting the establishment, the attitude of the seller regarding his business and his employees, and the attitudes of the employees to their boss and job assignments. Did the clerks call their regular customers by name? Were extra services performed without cost and with a smile? Was the proprietor involved with community affairs, and how was he regarded in the community? Would I return to that particular business for their products, knowing full well there was a competitor just a few miles away? These are the kinds of thoughts and questions that came to mind as I sipped my ale.

The interesting thing is that by the time I finished my ale I knew what I needed to do, if anything, to wind up my report and publish it.

The fact is that a business is not completely definable in terms of dollars. It is a synergistic whole that includes the human elements. A business owner who has a positive outlook and is motivated to give the best darned products and services at a realistic price, is more apt to continue into the future than one who is dour and is lacking in a basic understanding of human nature. And, doesn’t the definition of goodwill value include wording regarding continuance of the business into the future?

Doesn’t a low employee turn-over rate have an implied value, as does the inventory turn-over rate? And, isn’t the fact that employees go to great efforts to produce quality products in the least amount of time as important as the acid test of current liabilities to current assets?

To be continued on Thursday…