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Business Valuation: Focus on Cash Flows


Business valuations are particularly sensitive to three main factors: cash flows, the discount rate, and the discounts for lack of marketability and lack of control. Attorneys often spend significant cross-examination time on a valuation expert’s selected discount rate and the discounts for lack of marketability and control. Alternatively, in our experience, the cash flows estimated by the business valuation analyst receive relatively little attention even though they can contain many more nuances and assumptions. Similarly, we regularly see valuation analysts take management’s cash flow projections at face value and enter them straight into their valuation model. This happens all too often with little to no due diligence.

It’s important that valuation analysts pressure test prospective financial information provided by the client and push back on assumptions that don’t make sense or aren’t supportable. It’s equally important for attorneys to understand the responsibilities of a valuation analyst with respect to client-prepared projections in order to effectively cross-examine a valuation analyst’s cash flow assumptions. 

What to Pressure Test

Below are some suggestions for valuation analysts in their effort to pressure test management’s cash flow projections. These considerations can also be used as an effective cross-examination checklist for attorneys:

  • Determine whether management has a history of creating long-term projections.
  • Determine whether management’s projections were prepared in the ordinary course of business.
  • Verify that the calculations in management’s projections are mathematically correct.
  • Compare current projections against actual historical performance trends. Does management’s explanation of any discrepancies make sense?
  • Compare past projections to actual historical results in order to assess management’s projection track record.
  • Compare projections to economic and industry expectations. Are revenue growth rates reasonable? Are capital expenditure and working capital forecasts in line with industry trends?  If not, does management’s company-specific explanation make sense?
  • Verify that the company has the capacity to reach the level of operations projected by management. If not, has management considered the necessary capital expenditure required to achieve the growth forecast in the projections?
  • Make any necessary adjustments. Is the expense structure consistent with prior years? Are all expenses at market rates?

The list above isn’t an all-encompassing list, and depending on the facts and circumstances at hand, some tests may carry more weight than others. However, insufficient time spent on a company’s projected cash flows can create many problems, a few of which include:

  1. The selected discount rate does not match the level of risk embedded in the estimate of cash flows. Valuation analysts are responsible for matching risk with the level of expected cash flows. It’s important the valuation analyst understand the inputs and assumptions in management created forecasts in order to adequately assess the riskiness of achieving the forecast. Management may (inadvertently or on purpose) introduce biases in the development of projections. A valuation analyst can neutralize this with an appropriate adjustment to the discount rate, but only after a deep understanding of the projections in the context of expected market performance.
  2. Long-term cash flow assumptions do not match short-term cash flow assumptions. All long-term cash flow assumptions must be selected in the context of short-term assumptions. For example, it is difficult for a valuation analyst to select a supportable long-term growth rate without understanding how the company plans to achieve its near-term growth projections. This also applies to the timing of the terminal period (which accounts for operations into perpetuity), since management’s projection period may not necessarily coincide with growth stabilization. Is growth expected to stabilize to a long-term rate after year 5? Year 7? Year 10?
  3. Management’s projections may contain assumptions that are inconsistent with the standard of value. If this is the case, management’s projections may still require normalizing adjustments. Officer compensation or rent may not be stated at market rates, and personal or discretionary expenses may be included in projected expense items. The only way to identify areas for adjustments are via management interviews and financial analysis, including margin and trend analysis.

For more information, contact Jason Buhlinger, Principal, Transaction Advisory and Litigation Support Services, at or Matt Byford, Manager, Transaction Advisory and Litigation Support Services, at 


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