A Comprehensive Guide to Evaluating Private Companies in Australia
Evaluating a private company or a business in Australia can be a complex task due to the limited availability of financial information compared to publicly listed companies. However, a systematic approach to assessing a company’s financial health, industry positioning, and growth potential can provide valuable insights for business owners, investors as well as accountants, and advisors.
This article will guide you through the key steps and considerations for evaluating a private company or business in Australia, helping you make well-informed decisions. It also aims to equip business owners with the knowledge of the basics that contribute to enhancing their business value, in preparation for their succession planning or business sale.
1. Understand the Company and Its Industry
Before diving into financial analysis, it is essential to understand the company’s business model, products or services, and competitive landscape. Research the industry in which the company operates, as well as its market size, growth trends, and key competitors. This information will help you identify the company’s unique selling points and evaluate its position within the industry.
2. Gather Financial Information
Private companies in Australia are not required to disclose financial statements publicly, but you can request this information directly from the company if you have a legitimate interest (e.g., as a potential investor or creditor). You may also find some financial information in the Australian Securities and Investments Commission’s (ASIC) business name register or through industry-specific databases.
3. Analyse Financial Statements
Once you have obtained the financial statements, perform a thorough analysis of the company’s financial health by assessing the following key areas:
- Profitability: Analyse the company’s income statement to evaluate its ability to generate profits. Key ratios to consider include gross profit margin, operating profit margin, and net profit margin.
- Liquidity: Assess the company’s ability to meet short-term obligations by analysing its balance sheet. Key liquidity ratios include the current ratio, quick ratio, and cash ratio.
- Solvency: Evaluate the company’s long-term financial stability by analysing its debt levels and ability to meet long-term obligations. Key solvency ratios include the debt-to-equity ratio, equity ratio, and interest coverage ratio.
- Efficiency: Analyse the company’s ability to manage its resources effectively by assessing its operational efficiency. Key efficiency ratios include inventory turnover, debtors (accounts receivable) turnover, asset turnover, working capital ratio, workplace productivity, cash conversion cycle, and LER – Labour Efficiency Ratio.
4. Perform a SWOT Analysis
A SWOT (Strengths, Weaknesses, Opportunities, Threats) analysis is a strategic tool used to identify the internal and external factors that may impact a company’s success. Consider the following factors:
- Strengths: Identify the company’s competitive advantages, such as proprietary technology, strong brand recognition, or a loyal customer base.
- Weaknesses: Determine areas where the company may be lacking, such as outdated technology, a limited product range, or a high employee turnover rate.
- Opportunities: Identify external factors that may present growth opportunities for the company, such as industry trends, new market segments, or regulatory changes. Assess potential internal improvements and work out the financial implications on the business value.
- Threats: Assess potential challenges that may negatively impact the company’s performance, such as increased competition, economic downturns, or supply chain disruptions as well as internal innefiencies.
5. Assess Management and Corporate Governance
The quality of a company’s management team and corporate governance practices can significantly impact its performance. Research the backgrounds and experience of key executives and board members and evaluate their track record in managing similar businesses. Additionally, review the company’s governance practices, such as board composition, shareholder rights, and disclosure policies, to ensure they align with best practices and promote accountability and transparency.
6. Consider Intangible Assets
Intangible assets, such as intellectual property, brand value, and customer relationships, can contribute significantly to a company’s profitability and value. Assess the company’s intangible assets by evaluating its patents, trademarks, copyrights, and other proprietary knowledge. Consider the company’s reputation, brand recognition, and customer satisfaction levels, as these factors can also impact its overall value and future growth potential. Goodwill must be thoroughly examined and the subjectivity in the valuation must be properly understood.
7. Conduct a Valuation
Once you have analysed the company’s financial health, competitive position, and intangible assets, you can estimate its value using various valuation methods. Common valuation techniques include:
- Discounted CashFlow (DCF): This method involves projecting the company’s future cashflows and discounting them back to their present value using an appropriate discount rate. DCF is widely regarded as the most accurate valuation method, as it considers the time value of money and the inherent risk of future cashflows.
- Comparable Company Analysis (CCA): This method involves comparing the company’s valuation multiples, such as price-to-earnings (P/E), price-to-sales (P/S), or enterprise value-to-EBITDA (EV/EBITDA), to those of similar companies in the same industry. CCA provides a relative valuation and can be useful in identifying industry trends and assessing the company’s valuation relative to its peers.
- Precedent Transaction Analysis (PTA): This method involves analysing the valuation multiples paid in similar transactions within the same industry. PTA provides insights into how the market has historically valued similar companies and can help identify potential acquisition or investment opportunities.
REMEBER:
Albert Einstein
Everything that can be counted does not necessarily count; everything that counts cannot necessarily be counted.
8. Assess the Company’s Growth Potential
Evaluate the company’s growth prospects by considering factors such as its market share, target market size, and potential for expansion into new markets or product lines. Analyse historical growth trends and projections and assess the company’s ability to achieve its growth targets. Additionally, consider external factors such as macroeconomic conditions, industry trends, and regulatory changes that may impact the company’s growth potential.
9. Identify Risks and Uncertainties
No investment is without risk, and it is essential to identify potential risks and uncertainties that may impact the company’s performance. Consider both internal and external risks, such as operational risks, market risks, financial risks, and regulatory risks. Evaluate the company’s ability to mitigate these risks through effective risk management practices, strategies, and its governance quality.
10. Make an Informed Decision
After conducting a thorough evaluation of the private company, you should have a comprehensive understanding of its financial health, competitive position, growth potential, and associated risks. Use this information to make an informed decision about whether to invest in, lend to, or partner with the company. Keep in mind that no evaluation method can guarantee success, and it is essential to continually monitor the company’s performance and adjust your assessment accordingly. Make sure to hire accountants, solicitors, or advisors who have good commercial and business knowledge, experience, and can help with the necessary due diligence.
Evaluating a private company or a business can be a challenging task, but a systematic approach that combines financial analysis, strategic assessment, and risk identification can provide valuable insights into the company’s overall health and potential for growth. By following the steps outlined in this guide, you will be better equipped to make well-informed decisions about private companies and contribute to your professional success as a business owner and investor.
EBITDA – What to watch out for:
Whilst EBITDA is widely used and simplifies comparisons to similar industries, it is useful for high-growth businesses as it talks more about related profitability and growth. However, attention must be paid to some of the EBITDA shortcomings. Amongst the main ones is the fact that EBITDA ignores changes in working capital as it does not account for inventory, debtors (accounts payable), or creditors (accounts payables). It fails to consider capital structure or debt obligations. It is also critical to remember that EBITDA does not represent cashflow and can wildly differ from the actual cashflow.
RED FLAGS to watch out for in the financial reports:
- Very high Goodwill
- Rising days debtors (days receivables)
- Inventory rising faster than profits
- Excessive loans, borrowings, ODs (overdrafts); high tax debts; legal provisions
- Revenue and Net Profit persistently trending in opposite directions
- Capitalising R&D and interest costs
- Net profit lower than cash from operations
- A sharp decline in taxes
- Abrupt change in accountants or auditors, sudden exits of senior management or board members, and excessive management compensations.
By Gregory Atamian JJN Associates – Accountants Tax Advisor
The content and the references made in this article are correct as at the publication date and are for general information and should not be relied upon as advice. If you wish to seek particular advice, call us on 02 9997 4000.