31 Mar 2020
Coronavirus and the Impact on Business Value
Understandably, many business owners are concerned about the coronavirus impact on business value.
As many businesses enter the third week of closure due to the coronavirus pandemic, business owners face an unprecedented challenge on keeping their businesses alive. While some businesses have mitigated their losses through online sales or offering delivery services in lieu of physical storefronts, others have temporarily closed their doors and laid off staff in order to mitigate the virus spread and operating losses.
Given the pervasiveness of the pandemic on businesses and individuals alike, the impact on business value is top of mind.
While the outlook may seem bleak right now, the Canadian and U.S. governments have proposed new measures to help soften the blow on businesses including:
The Wage Subsidy Program (Canada)
Coronavirus Aid, Relief, and Economic Security Act (CARES Act - USA)
In a valuation context, this means businesses still have value assuming operations will return back to normal eventually.
Fundamental to business value and the preservation thereof is the company’s cash flows. When a company is unable to generate positive cash flows over an extended period of time or if the company does not have any significant business operations, then the highest value of the company would typically equate to the underlying net assets the company holds. In this case, the company would be valued by an Asset Approach.
If, on the other hand, the company has historically been profitable, the value of the company will be determined by either an Income Approach or a Market Approach.
Income Approach – This approach focuses on determining what the future expected cash flows of the business will be and discounting these future cash flows to present value in order to determine the value of the business.
Market Approach - The Market Approach involves selecting a list of comparable companies and applying the multiples observed in these comparable companies to the subject company to derive its value.
As you may have noticed, given that future cash flows are paramount to determining the value of a business, the coronavirus impact on business value has presented a unique dilemma since many business owners will not know what their cash outlook will be like in the next few months.
Strategies for Mitigating Business Risk
Below are a few strategies and recommendations to assist business owners with mitigating business risk during this challenging time:
Be Proactive, Not Reactive – Notwithstanding the constant influx of news and distress arising from this pandemic, business owners will do well in planning their course of action for the next six months. As reacting to situations that have occurred in the past will have little value to the future of the business, business owners should begin planning on assessing their unique business circumstances and focus on mitigating any crises that arise in the next few months. This may include running three different scenario analyses ranging from good, neutral and bad to determine what course of action(s) to take in order to mitigate and ultimately recover from this pandemic. Inherent in these scenario analyses would be to prepare budgets and model out what level of cash can be retained in the business during this time.
Control Costs – As a short-term mitigating factor, business owners should review their business expenses and segregate business costs that are fundamental to the operations and costs that are discretionary. For example, while phone and website maintenance costs would be considered fundamental for a business to interact with customers during this time, other costs such as advertising, travel and education costs can be deferred until the business picks up again. Of course, every business is unique and what is considered discretionary to one business can be essential to another. Another strategy may be to work with staff to see if job sharing or reduced hours are viable alternatives in order to save on wage costs while at the same time, keep the business running.
Clean-up the Balance Sheet – Given the hectic day-to-day operations of a business, a business owner may not have the time to review their company’s balance sheet on a normal basis. Now would be a good time to start doing so. The focus here is for owners to focus on their core asset needs and convert any excess assets into cash. This would include cleaning up the accounts receivable balance and follow up on any outstanding collectible amounts from customers. On the other hand, business owners should consider negotiating with their vendors in delaying their amounts owed due to the crisis as vendors would rather get paid their full amount at a later date than risk having to collect pennies on the dollar from an insolvency trustee if the company ends up declaring bankruptcy.
Above All, Preserve Cash – As you may have noticed, all the above strategies focus on maximizing cash on hand since cash is king, especially during times of uncertainty. If the business owner is fortunate to have sufficient cash on hand to continue the business for the next few months, then the business will have a fighting chance to survive and rebound once the pandemic is over and the economy begins to recover.
While the coronavirus impact on business value may be challenging in the current economical environment, the decisions business owners make now and for the next six months will determine the overall viability of the company. Although the current environment does have a negative impact on business value, as can be seen through the volatility of our current stock markets, the business value can recover if business owners take a proactive step in maintaining their cash flows in the business. Once the cash flows of the company return back to normal, business owners can then see the values of their businesses to do the same. Although it may not be the first thought that comes to mind, business owners may find a silver lining through estate planning; given the depressed values in businesses right now, it may be a good time to freeze the value of the company and transfer any future growth to your next of kin.
We Are Here to Help
Manning Elliott is here to help. To assist business owners in navigating through these trying times, visit our blog to stay up to date on the most recent activity related to COVID-19.
If you have any questions on how to strategize your business during this time, including cash flow management, budget forecasting, and valuing your business, please contact William Tam, CPA, CA, CBV directly.
This content is believed to be accurate as of the date of posting. Canadian Tax laws are complex and are subject to frequent change. Professional advice should be sought before implementing any tax planning. Manning Elliott LLP cannot accept any liability for the tax consequences that may result from acting based on the information contained therein.