A Key Factor in Valuing Your Business: Trailing Twelve Months Earnings

By / 11 months ago

MERGERS & ACQUISITIONS

Let’s say it’s OCT. 1, 2016, and you are in the process of selling your company.

Let’s also say that your financial statements are prepared on a calendar year (Jan. 1 to Dec. 31, 2016). In other words, you are still three months shy of completing your calendar year.

Let’s also assume that you are having a killer year in sales. My goodness, you haven’t put up sales numbers like these since before the Great Recession! Salesmen had a snap in their steps; there’s a gleam in the eye of the owner, and everyone’s feeling confident. What’s more, since you’ve taken strong steps to control your costs in recent years, the strong sales figures are contributing to a healthy bottom line. Your company earnings haven’t looked this good in years.

Since you are selling your company, the main question on your mind is simple: “Even if we have not completed the current 2016 calendar year, how can we use these strong 2016 earnings in the calculation of our company’s valuation? How can we avoid tying our value solely to the 2015 calendar year?”

Your concern is very real, and it can mean the difference between taking home a great sum of money upon the sale of your company…or leaving a pile of it on the table.

To underscore the importance of this issue, let’s do some quick math. Today, lumber dealers are being acquired for multiples between 5X and 7X of EBITDA. Make no mistake, 7X is the top of the market today; it’s being paid by buyers who perceive must-have strategic importance in businesses they are acquiring. That said, if you’re a successful lumber dealer, it’s likely that you’ll be acquired for around 5.5X EBITDA or slightly higher.

Knowing that multiple, get your calculator and run some numbers. For every $100,000 you add to your EBITDA, you are rewarded with an additional $550,000 in company value at the time you are acquired.

If your EBITDA in calendar year 2015 was $1,000,000, and you’re acquired for 5.5X, then the total enterprise value (TEV) of your company is $5,500,000.

If you had added $100,000 to the EBITDA in 2015, your company value would have been $1,100,000 x 5.5, or $6,050,000, a nice lift. In other words, you are essentially getting $5.50 in increased TEV for every $1 you add to EBITDA.

If it’s October, and your 2016 calendar year is not yet complete, you surely have sales projections for the rest of the year. Projections are well and good, but an acquirer will want to see actual EBITDA, on a historical basis. They have only so much faith in projections. After all, investors are naturally cautious. Who know what could happen in the remaining months of the 2016 calendar year? A weather calamity? Faltering health of a key company owner? Another 9/11 attack?

The path to obtaining the valuation boost you deserve for strong ongoing earning is a trailing twelve months earnings calculation, also known as “TTM.”

By presenting TTM to a potential acquirer, you are essentially showing them the results of your last 12 months of performance, but not your official calendar year. Instead, you are showing them EBITDA from, per se, a rolling fiscal year that ends on this last day of every previous month. Very simply put: TTM rewards you for your very latest earnings performance.

As you move deeper into your company’s real calendar year, you should still calculate your TTM after every month, whether you are selling your company or not. Be sure to load in ALL your ongoing costs; don’t wait until year-end, because you’ll be deceived by phantom earnings.

With the TTM calculation, you also have your finger directly on the pulse of your business. You can detect— practically in real time—if the company’s earnings are turning sour and need help, or when earnings are going through the roof, confirming you’re on the right track. Waiting to the end of the calendar year to calculate EBITDA doesn’t give you much chance for mid-course fix, unless you’ve mastered the ability to go back in time, and everyone knows only Michael J. Fox and Doc Brown can do that.

Finally, TTM is a widely accepted metric in the mergers and acquisitions sector, since it reflects your actual performance over the last twelve months. By using TTM, and insisting that you get a multiple of earnings on your current sales, and not those from a year ago, TTM can help you ask for the highest possible value for your business at the time of sale.

John D. Wagner

John Wagner is a managing director at 1st West Mergers and Acquisitions, which offers a specialty practice in the LBM sector. Learn more at: www.1StWestMA.com. Contact John at: j.wagner@1stWestMA.com.