Going-Concern Value: Value of a Company as an Ongoing Operating Business

The going-concern value represents the value of a company as an operating business, distinct from the value of its individual assets or liquidation value. It is crucial for business valuations and mergers and acquisitions.

Going-concern value represents the worth of a company assuming it will continue its operations into the foreseeable future. It is a critical concept in business valuation, mergers and acquisitions, and credit analysis. Unlike asset valuation, which focuses solely on the value of individual assets, going-concern value considers the company as an integrated, revenue-generating entity.

Distinction from Liquidating Value

Going-concern value is different from the liquidating value, which is the net amount that can be realized if the company’s assets were sold off individually. The going-concern value typically exceeds the liquidating value due to several factors:

• Operational Synergies: The integrated operation of different assets and departments can create additional value.
• Goodwill: Intangible assets like brand reputation, customer relationships, and employee know-how.
• Earnings Power: The company’s ability to generate future profits.

Example Calculation

To illustrate, consider a company with the following components:

• Assets: $10 million
• Liabilities: $4 million
• Net Asset Value (NAV): $6 million

If the company is valued as a going concern:

• Expected Future Earnings: $2 million annually
• Appropriate Discount Rate: 10%

The Present Value (PV) of expected future earnings:

$$ PV = \frac{Earnings}{Discount\ Rate} = \frac{2\ million}{0.1} = 20\ million $$

Thus, the going-concern value would be:

$$ Total\ Value = Net\ Asset\ Value + Present\ Value\ of\ Future\ Earnings $$

$$ Total\ Value = 6\ million + 20\ million = 26\ million $$

Here, the excess over the NAV ($20 million) represents the going-concern premium.

Historical Context

The concept of going-concern value has evolved along with accounting practices. Historically, businesses were often valued based solely on their asset value. The inclusion of operational and earnings potential marked a significant shift in valuation methodologies, emphasizing the importance of continuous operation and strategic management.

Applicability

Going-concern value is particularly relevant in:

• Mergers and Acquisitions: Assessing the value of a target company.
• Investment Analysis: Evaluating long-term investment opportunities.
• Creditor Decisions: Determining creditworthiness and loan terms.

Goodwill and Going-Concern

Goodwill, often considered alongside going-concern value, refers to the excess value created by intangibles such as brand reputation, customer loyalty, and strategic locations. In financial reporting, goodwill is recorded when a company acquires another for more than its identifiable net asset value.

FAQs

Q: What is the key difference between going-concern value and liquidating value? A: Going-concern value includes the expected future earnings and operational synergies of the business, while liquidating value focuses solely on the asset sale proceeds minus liabilities.

Q: How does going-concern value impact financial statements? A: It can influence asset valuations and the recognition of goodwill in financial reports, affecting a company’s balance sheet and overall perceived valuation.

Q: Why is going-concern value important for investors? A: It provides a more comprehensive understanding of a company’s worth, considering its ability to generate future profits and sustainably operate.

Related Terms

• Goodwill: An intangible asset arising when a buyer acquires an existing business.
• Economic Value Added (EVA): A measure of a company’s financial performance based on residual wealth.
• Net Asset Value (NAV): The value of an entity’s assets minus liabilities.

Summary

Going-concern value is essential for comprehensively evaluating a business, considering its entire operational capability and future profitability beyond just its current asset value. This concept plays a pivotal role in various financial contexts such as mergers and acquisitions, investment evaluations, and credit analysis, distinguishing it from the more limited liquidating value approach.

References

• Damodaran, A. (2012). Investment Valuation: Tools and Techniques for Determining the Value of Any Asset. John Wiley & Sons.
• Pratt, S. P. (2008). Valuing a Business, 5th Edition: The Analysis and Appraisal of Closely Held Companies. McGraw Hill.
• “Financial Accounting Standards Board (FASB)”, Goodwill and Intangible Assets: Concepts and Practices.

By understanding the going-concern value, stakeholders can make more informed decisions regarding the true worth and potential of ongoing businesses.