When businesses suffer a disaster such as a fire, flood, or storm, the damages caused can significantly reduce their value. In these unfortunate circumstances, a business owner may need to complete a comprehensive business valuation to determine their company’s reduced value for various purposes, including insurance claims, litigation disputes, financial and debt negotiations, sale or liquidation, and more. When a business valuation is required for litigation purposes, the parties involved must hire a reputable forensic economics firm to complete a thorough and accurate valuation and present the findings in clear and understandable language during expert witness testimony.
At The Knowles Group, we have years of experience successfully helping plaintiffs and defense construct an accurate economic picture of past and post-disaster financials and losses. Contact us today to learn how our services can help bolster your arguments and explain complex economic theories in easy-to-understand layperson’s terms.
What is a Business Valuation, and Why is it Important?
Business valuation is a process and set of procedures used to estimate the economic value of a business. It involved the systematic evaluation of all aspects, both tangible and intangible, that contribute to the business’s economic value.
Expert forensics use business valuations in the aftermath of a disaster, whether natural or man-made, to systematically analyze and estimate the financial and economic damages a business has incurred. An accurate business valuation completed by an expert forensic can be used for the following purposes:
- Determining Economic Damages by evaluating the disaster’s impact on a business’s tangible and intangible assets to determine the cost of repair or replacement.
- Calculate Losses Due to Business Interruption, including lost profits and additional expenses, by analyzing the business’s historical financial data and trends.
- Quantify Loss in Business Value resulting from the disaster by comparing pre-disaster and post-disaster valuations to determine the value reduction.
- Provide Insurance Claim Support to determine fair insurance settlements by substantiating or refuting claims using valuation reports outlining economic damages in detail.
- Litigation and Dispute Resolution through expert witness testimony and economic analysis to aid in legal proceedings related to disaster damages.
- Strategic Recovery Planning by providing insight into potential financial adjustments, additional investments, and operational changes needed to rebuild and recover.
- Financial Negotiations and Debt Restructuring by presenting clear and detailed valuation reporting required by financial institutions.
- Aid in Tax Preparation by helping business owners understand and navigate Internal Revenue Service implications of a disaster and optimize their tax positions.
- Communication with Investors and Stakeholders by providing comprehensive information to transparently and effectively convey financial status and recovery plans.
- Evaluating Long-Term Economic Impact by analyzing the long-term economic impact to create projections and forecasts for future decision-making.
How Expert Forensics Determine Business Value After a Disaster
Forensic economists use a meticulous approach when completing business valuations, regardless of the circumstances. These methods must be transparent and defendable under the scrutiny of a court or insurance company. The following is a general overview of how an expert forensic might approach this:
Collect Pre-Disaster Financials
An accurate business valuation begins with a thorough review of all historical financial statements, including balance sheets, business income, and cash flow statements, along with any business plans, projections, and budgets that existed before the disaster. In addition to financial metrics, the expert forensic will also analyze non-financial metrics such as the business’s pre-disaster customer base, market share, and supplier relations. This pre-disaster information will form the baseline data used to complete all future projects and forecasting.
Assess Physical Damages
Next, a comprehensive analysis of all physical damages, including damaged assets, stock, inventory, etc., is completed to determine the value of physical damages. This includes determining any diminution in the value of remaining assets (for example, a partially damaged building after a fire). Once an expert forensic assesses all physical damages, they can calculate estimated replacement and repair costs for all asset damages.
Calculate Lost Profits Due to Business Interruption
Once the value of physical damages is determined, the expert forensic must calculate the economic impact of business interruption using historical and projected data. This involves considering many factors, including the duration of the interruption, the time required to return to full operations, the impact on customer base and supplier relations, and accounting for any saved or avoided costs during the interruption (i.e. reduced cost of labor). These factors contribute to the lost profits calculation due to business interruption.
Consider Insurance and Compensation
If the business is adequately insured, the insurance company will likely award compensation based on the coverage limits like business interruption coverage, deductibles, and any potential exclusions. These insurance payouts must be subtracted from the estimated losses to determine an accurate business valuation.
Discount Future Losses to Present Value
Finally, the expert forensic must discount any future losses suffered by the business to their present value to reflect their current worth.
Factors to Consider When Conducting Business Valuation After a Disaster
To perform a comprehensive and accurate post-disaster business valuation, expert forensics must meticulously evaluate several factors to ensure the valuation adequately reflects the disaster’s economic impact. These factors include but are not limited to
- Nature and Extent of the Damages
- Business Interruption Period
- Historical Financial Performance
- Market Conditions
- Impact on Management and Workforce
- Risks and Uncertainties
Nature and Extent of the Damage
The nature and extent of the damages incurred by a business are the primary factors influencing a business’s value after a disaster and will determine recovery and rebuilding costs. This includes damage to physical assets, inventory, and other properties and the impact these damages will have on operations, production, and service delivery. The nature of the damages will also affect a business’s eligibility for insurance coverage and potential settlement payouts.
Business Interruption Period
The length of business interruption can significantly impact the value of a business depending on the impact that reduced or halted operations have on sales and the company’s historical financial performance before the disaster.
Historical Financial Performance
Past financial records provide a baseline for estimating future revenue, cash flow, and profitability to make informed projections regarding the future performance of a business and its estimated value.
The greater economic market surrounding a business must also be considered after a disaster. The expert forensic must account for factors like post-disaster market demand, competition, industry trends, changes in consumer behavior, supply chain interruptions, and regulatory changes to gain an accurate picture of the business’s future operational landscape and the effect this new landscape will have on overall value.
Impact on Management and Workforce
The effects of a disaster impact the business’s management and workforce as much as they do the business owner. The impact of the disaster on employees, management, and the organization’s overall structure will impact the business’s capability to operate, impacting the business’s value.
Risks and Uncertainties
After a disaster, risks and uncertainties tend to increase due to changes in operational and market conditions. When calculating valuation, the expert forensic must consider these risks and uncertainties to determine an accurate discount rate.
Common Business Valuation Methods Used by Forensic Economists
Expert forensics typically use one or a combination of multiple established business valuation methods and techniques specific to post-disaster scenarios. Besides these standard methods, expert forensics also utilizes various specialized techniques and considerations. The primary methods include
The Income Approach
The income approach is based on the expectation of the economic benefit and risk that may be received and incurred in the future. This method values a business based on the present value of expected future cash flow and earnings, using an appropriate discount rate based on the risk profile of the business post-disaster by adjusting the projected cash flows to account for the disaster impact on future revenue and expenses.
The Market Approach
The market approach compares the damaged business to recently sold similar competing companies by utilizing comparable sales adjusted for differences in size, location, and other factors. This approach is particularly useful for expert forensics in litigation, dispute resolution, and different scenarios where an objective, measurable, market-based valuation is required. It should be noted that finding relevant comparable sales can be challenging after a disaster if it has affected an entire region or industry.
The Asset-Based (or Cost) Approach
The asset-based or cost approach values a business based on the current value of its assets minus its liabilities. After a disaster, the asset-based approach requires adjusting the value of all tangible and intangible assets damaged or destroyed. It must factor in depreciation, obsolescence, and any other devaluation caused by the disaster. This approach is particularly relevant for businesses with significant tangible assets and in cases of liquidation or bankruptcy, where the business value is primarily derived based on the underlying assets rather than revenues or other market comparisons.
We Provide Accurate Business Valuation After a Disaster
At The Knowles Group, our decades of experience determining economic damages have given us the unique ability to provide expert business valuations for large and small business owners based on scientific and economic principles and convincingly testify in a court of law. As your expert business loss witness and business valuation witness, we will get to know even the most niche of markets as we uncover the economic viability of your business, dispute our counterpart’s assertions, and explain in easy-to-understand terms why we feel that the opposing expert opinions are unreasonable, exaggerated, or unsubstantiated.
If you require a post-disaster business valuation, contact us today to schedule a complimentary case consultation and learn how we can help your case.