Business advisor can help determine firm's value

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Most business buyers know that the earnings reflected in an acquisition target's balance sheets require many adjustments. |ret||ret||tab|

But they may be unaware of important quality-of-earnings issues that can drastically affect the value of the business.|ret||ret||tab|

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Quality-of-earnings factors|ret||ret||tab|

A business owner who plans to sell the business may, for example, cut discretionary spending in several operating areas to make earnings look better than they are.|ret||ret||tab|

While these cuts may indeed improve earnings in the short term, they can lead to a long-run competitive disadvantage for a buyer and even result in the company's insolvency. |ret||ret||tab|

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Looks can be deceiving|ret||ret||tab|

Assume two companies, Technowiz Corp. and Compuworks Inc., manufacture personal computers and operate in a highly competitive market. |ret||ret||tab|

They have equal levels of annual sales and costs of sales, but Technowiz has substantially higher operating expenses. |ret||ret||tab|

Without further analysis, Compuworks appears to have a leaner operation and thus seems the better target. But is this an illusion? Consider these factors:|ret||ret||tab|

Technowiz has been preparing to introduce a new computer line that will make its current offerings obsolete in terms of cost and efficiency. |ret||ret||tab|

Compuworks has decided to concentrate on its successful product line and has reduced its research and development expenses, resulting in operating expenses that are $100,000 lower.|ret||ret||tab|

Technowiz has hired an additional salesperson to promote its products and is well-positioned to capitalize on sales of its new product line. |ret||ret||tab|

Compuworks has not hired any new sales personnel. In fact, the company has decided its products are well-known in the marketplace and has cut its advertising expenses by $50,000 reducing its operating expenses by that amount. |ret||ret||tab|

Technowiz is a stickler when it comes to maintaining its machinery, cleaning and checking its equipment monthly. |ret||ret||tab|

Compuworks checks and cleans its equipment only when something breaks.|ret||ret||tab|

Because Technowiz spends an average of $50,000 more in maintenance expenses every year than Compuworks, Technowiz on average needs to replace its machinery only every 10 years. |ret||ret||tab|

Compuworks must replace its machinery every seven years and is expecting to replace 50 percent of its equipment within the next year.|ret||ret||tab|

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Which has better prospects?|ret||ret||tab|

Now that you know some of the specifics about the two companies, which one is worth more? Would an analysis of the companies' financial statements lead you to the same conclusion?|ret||ret||tab|

Ask your business adviser to help you uncover important quality-of-earnings issues in prospective acquisitions. When you know all the facts, you can make good decisions.|ret||ret||tab|

|bold_on|(Tom Beisner is a partner with Whitlock, Selim & Keehn LLP, a certified public accounting and business consulting firm.)|bold_on||ret||ret||tab|

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