Although one of the first things we ask for when preparing a business valuation is the company’s previous five years of financial statements, this isn’t the only information we rely on. The concept of business valuation is forward-looking. For stable businesses, past earnings are generally indicative of expectations for future earnings. However, in situations where the business is going through significant changes (e.g. introducing a new product line or substantially cutting costs by outsourcing certain activities) it is necessary to review and analyze projections of future earnings in coming to an estimate of business value.
In our experience, most companies that are anticipating significant changes have prepared projections and potentially completed some sensitivity analysis before carrying out their plans. However, in cases where projections have not been prepared, we usually ask management to give some thought to the expected changes to come and what the financial impacts of those changes might be. While we rely on management to prepare the projections, we will also perform our own sensitivity analysis when evaluating the impact of these projections on business value.