Forecast Based on Historical Trends
It is common to see a Discounted Cash Flow in a business valuation report. With COVID-19 in the recent past, the business valuation community is aware of using prior data that is no longer reliable. If a company has experienced a downturn and has not fully recovered to the pre-COVIDS-19 time, using the historical revenues to make a forecast could indicate a bias on the part of the expert.
For the COVID-19 year (2020), the client had a decrease in revenues from the 2019 year of 30%. Without any supporting evidence, the experts increased the 2021 years revenues by approximately 40%, while still struggling with COVID-19.
As a result of the unreasonable assumptions, the forecasted revenues and operating income far exceed the actual results of the company. The actual revenues for the 2021 year were approximately 13 million. The biased forecast for the 2021 revenues was almost 19 million. Almost 6 million overstatement in the first forecast period. This biased forecast continued to compound the unreasonableness for an additional four years.
Chart the Data
When working with financial data, it is always helpful to chart the data to assist in detecting trends in both the historical and forecasted data. The chart below demonstrates the data I have been discussing. It can be seen that the revenues and operating income do not follow the historical trends and far exceed the historical trends.
It is imperative that a forecast be prepared with a critical eye and continually look for any indications of bias. The business valuation report is supposed to be impartial and when preparing the analysis, a close eye should review the analysis looking for indications of unreasonableness and/or bias.
Richard Claywell has been valuing closely held companies since 1985. He has earned two of the highest designations in the business valuation field , the Certified Business Appraiser (“CBA”) and Accredited Senior Appraiser (“ASA”), Richard is a Certified Public Accountant, has a Master’s in Business Valuation and holds the ASA, CBA, ABV, ICVS, CVA, MAFF, CFD, CVGA, ICVS-A credentials.