Forecasts of future cash flows within the income approach to business valuation are loaded with assumptions. During my nearly two decades of business valuation experience, I have reviewed hundreds of valuation reports prepared by other experts that serve as a constant reminder that mathematical accuracy does not always equate to a reasonable value. I have seen erroneous assumptions made by business appraisers that range from illogical disconnects within the valuation to outright errors or unsubstantiated speculation.
Business appraisers must often deal with financial forecasts in their valuation of private companies. Sometimes, the financial forecasts or projections used by the appraiser in a discounted or capitalized cash flow model are provided by management, in which case the appraiser might:
Regardless of the method the appraiser uses, there are numerous assumptions in a cash flow forecast that must be adequately analyzed and supported, the absence of which may cause an overvaluation or undervaluation of the company.
In this three part blog series, I will point out common issues I have observed in my review of valuation models and reports. I will focus on the forecasts of:
Look beyond mathematical accuracy. Without adequate analysis and support, the assumptions and related ratios embedded in the forecasted cash flows used in a capitalized cash flow model or in the calculation of the individual forecast years and the terminal value in a discounted cash flow model can lead to an unreasonable value.
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