How we value industrial businesses

Why isn't a factory just an EBITDA multiple?

A buyer of an industrial business is buying future cash flow, and whatever it takes to keep producing it. Two companies with the same EBITDA can need very different amounts of capital, carry very different customer risk and depend on their owners to very different degrees. The multiple is the output of that analysis, not the starting point.

We think of enterprise value as drawing on eight components. None of them is simply added to the others. They interact, and the interaction is where most of the judgement in an industrial valuation sits:

• Earnings: what the business makes once the owner's role, related-party rent and one-off items are put on a market footing.
• Plant and equipment: whether the machines and fleet can keep producing those earnings, and what it will cost to replace them when they cannot.
• Working capital: the debtors, stock and work in progress a buyer has to fund to keep the doors open.
• Customer relationships: how concentrated the revenue is, and how much of it would follow the business to a new owner.
• Contracts: supply agreements, panel positions and maintenance contracts, their remaining term, and whether they survive a change of control.
• Intellectual property: designs, tooling, processes and software, and whether the company or the owner personally holds them.
• Operational capability: certifications, skilled people, systems and spare capacity that let the business win work and deliver it.
• Growth prospects: what the business can realistically become, and the capital and people that would take.

The components do not add up. They interact.

Machines bought for one customer's program are worth a great deal while that customer keeps ordering and far less if it leaves. A supply agreement with years to run changes how a buyer reads the same revenue. That is why specialist judgement matters more than the arithmetic.

Which valuation method fits an industrial company?

The method depends on the business and the purpose of the valuation. Most industrial valuations use one primary method and at least one cross-check. These are the approaches we consider, and where each one earns its place.

In capital-intensive businesses we pay close attention to which earnings figure is capitalised. Depreciation in a machine shop or a trucking fleet is a real cost, because the equipment wears out and has to be replaced, so EBITDA on its own can overstate what a buyer will pay. We explain the trade-off in EBITDA vs EBIT in industrial business valuations.

What goes into an industrial business valuation?

We analyse eight areas. The weight each one carries depends on the industry: customer concentration dominates in contract manufacturing, fleet age and replacement spending in transport, and certifications and security obligations in defence supply.

Financial performance

Revenue, gross margin, EBITDA and EBIT for at least three years plus the current year to date, with owner adjustments and normalisation set out line by line. We separate price from volume where the data allows, check whether margins held when steel, resin, fuel or energy costs moved, and compare capital expenditure with depreciation over several years. A business that has spent well below its depreciation for five years has usually been running its plant down, and a buyer will price in the catch-up.

Customers

Revenue from the largest one, five and ten customers, and how that has moved. Whether supply sits on contracts, panel arrangements or purchase orders; remaining terms, renewal dates and change of control clauses; churn among smaller accounts; and pricing power, including rise and fall clauses and the ability to pass on cost increases. Geography matters too: a business serving one mining region rises and falls with it.

Operations

Capacity utilisation by shift and at the bottleneck machine, not just averaged across the plant. Whether growth needs another shift, another machine or another site. Scrap and rework, delivery performance, dependence on one site (a short lease, or zoning that limits operating hours) and the labour needed to run at the planned volume. Spare capacity has value only if there is demand to fill it.

Plant and equipment

The equipment register by asset: age, condition, hours, maintenance history, whether it is owned, leased or financed, and what is owing. We look for the replacement cycle the business has actually been running on and any backlog, how much of the plant is specialised to one customer or product, and finance balances against the agreements. Security interests registered on the Personal Property Securities Register over plant or stock can change what a buyer actually receives, so we ask about them.

Workforce

Who quotes, who programs the machines, who holds the customer relationships and who signs off quality. We look at management depth below the owner, people with scarce skills such as coded welders, CNC machinists who write their own part programs and licensed operators, reliance on overtime, the apprentice pipeline, and the award or enterprise agreement that sets labour costs, for example the Manufacturing and Associated Industries and Occupations Award 2020. A business whose owner is also the chief estimator is worth less to a buyer until that knowledge is written down or held by someone else.

Competitive position

Barriers to entry and switching costs: customer-approved processes, tooling, first article approvals, and the certifications customers require, such as an ISO 9001 quality system, AS/NZS ISO 3834 welding quality requirements, or Defence Industry Security Program membership for defence work. A qualification that takes a competitor a year to obtain is worth more than a price advantage that can be matched next month. Location counts as well: being close to customers, a port or a mine site can be a lasting advantage.

Intellectual property

Product designs and drawings, proprietary processes, jigs and tooling, software, brands and trade secrets, and above all who owns them. In private industrial companies a key design often sits with the founder personally or in a related entity, and production tooling sometimes belongs to the customer. Value follows ownership, so we confirm it rather than assume it.

Industry risk

Cyclicality, commodity exposure, regulation, supplier concentration and economic conditions. A fabricator tied to resources projects, a distributor relying on one overseas manufacturer for its exclusive rights, or a food manufacturer exposed to one retailer's range review each carries risk that three good years of profit may not show. We reflect that risk in the rate we apply or the cash flows we forecast, and the report says how.

How do we normalise the owner's role and related-party costs?

Private industrial businesses are run for their owners, and the accounts reflect it. Before earnings can be valued they are restated to what a buyer running the business at arm's length would face. The adjustments we make most often in industrial companies are:

• The owner's salary replaced with the market cost of the roles the owner fills, which is often general manager, chief estimator and key account manager at once.
• Family members on the payroll, at what their work would cost to replace.
• Rent paid to the owner's property entity adjusted to market rent, up or down.
• Vehicles and personal expenses that would not continue under a new owner.
• One-off items: a major breakdown, a settled dispute, an insurance recovery, a government grant that will not recur, or a stock write-down.
• Leases treated consistently, so that rent and equipment lease costs sit either in earnings or in debt, never in both and never in neither.

Normalised earnings are not yet maintainable earnings. We then ask whether the year was typical: a large one-off project, a customer that has since left, a price rise not yet passed through, or maintenance deferred to protect the margin. Maintainable earnings are what a buyer could reasonably expect to continue, and that is the figure the valuation rests on.

How are plant, working capital and surplus assets treated?

Plant and equipment

Where a business is valued on its earnings, the plant needed to produce those earnings is already inside that value, so it is not added again on top. The machinery is the reason the earnings exist. The written-down value in the accounts is a tax and accounting figure and tells us little on its own.

Plant comes into the valuation in three other ways. Sustainable capital expenditure is allowed for, so a fleet or machine base that is due for replacement reduces value. Finance owing on equipment is debt and is deducted. And in asset-heavy businesses with weak earnings, what the plant would realise in an orderly sale can set a floor under the value. A formal plant and machinery valuation, for finance, insurance or a sale of assets, is a separate discipline done by a plant and machinery valuer; where one exists, we can use it as an input. More in how plant and equipment affects business value.

Working capital

Enterprise value assumes the business changes hands with a normal level of working capital: debtors, raw materials, work in progress and finished goods, less trade creditors. If the actual level at the valuation date is below normal, the shortfall is deducted; if it is above, the excess can be added. Industrial businesses make this harder than most. Work in progress on fixed-price jobs may be billed ahead of the work or well behind it, a large customer may dictate long payment terms, and slow-moving stock can sit at cost long after it stops being saleable. We set the normal level from monthly balances where we can get them, not a single year-end snapshot. See how working capital affects a manufacturing business valuation.

Surplus assets

Assets the business does not need to earn its profits are valued separately and added: spare land, an idle machine, cash above operating needs, investments, and loans to shareholders or related entities. Where the company owns its factory, we agree at scoping whether the property is valued with the business or treated separately with a market rent charged against earnings. The property itself is valued by a property valuer.

What value are we measuring?

Unless the engagement requires something else, we value on market value: the price a hypothetical willing but not anxious buyer and seller, both fully informed, would agree in an arm's length transaction. The test comes from the High Court's decision in Spencer v Commonwealth [1907] HCA 82, and the ATO sets it out in its guide Market valuation for tax purposes.

Market value is not the price one particular buyer might pay for synergies only it can capture, and it is not a forced sale. Where a shareholders' agreement or the engagement requires a different basis, such as a defined fair value or a value with no discount for a minority interest, we value to that definition and say so in the report. How control and minority interests differ is covered on our shareholder valuation page.

What happens from enquiry to final report?

1. Enquiry. Tell us the industry, the purpose, approximate turnover and your timing through the quote form or on 0433 475 518. No documents at this stage.
2. Scoping call. A valuer calls to understand the business, the purpose, the valuation date, which entity or shares are being valued and who will rely on the report. If the operation or equipment needs to be seen, we say so here and agree any visit and its cost first.
3. Engagement letter. We confirm in writing the scope, the valuation date, the interests being valued, the intended users, the information we need, the fee and the delivery basis. We confirm the fee in writing before we start. No hourly billing.
4. Payment and documents. Once you accept and pay, you upload documents through the private link on your matter. Your accountant can upload on your behalf with your authority.
5. Analysis. We normalise the earnings, test them against capacity, plant and working capital, and send any questions through your matter. Most engagements include a conversation with the owner or manager about how the business runs day to day.
6. Draft and representation letter. You receive a draft to check the facts, such as machine ages, customer shares and finance balances, with a representation letter confirming that the information you supplied is complete and accurate. We correct any error of fact; the value itself is our independent opinion and is not negotiated.
7. Final report. Once the signed representation letter is back, the final report is issued through the client portal.

Delivery is 2 business days for a smaller industrial business and 3 business days for an established one. For complex and expert matters it is agreed before we start. Delivery time starts once payment and all required information have been received. Fees by band are on our pricing page.

What does the valuation report contain?

• The purpose, the scope, the intended users and any restriction on use.
• The valuation date and the exact interest valued: the business, all the shares, or a parcel of them.
• A description of the business and how it operates, in enough detail that a reader can see what drives its value.
• The information relied on and where it came from.
• The financial analysis, with every normalisation adjustment and the reason for it.
• The value drivers and risks specific to this business: customers, contracts, plant, people, capability and industry exposure.
• The method chosen, why it was chosen, and the cross-checks applied.
• How plant, working capital, debt and surplus assets were treated.
• The conclusion, with the reasoning behind any range or point value.
• Assumptions, limitations and the standards that guide the work.

That structure lines up with what the ATO says it expects in a valuation report used for tax purposes, and it lets an accountant, a co-shareholder or a buyer follow the reasoning without having to call us. A report prepared for a commercial purpose is not an expert report for a court or tribunal; court work is a separate engagement. You can see the layout on our sample report page.

Which standard guides our work?

Guided by APES 225 Valuation Services.

APES 225 is the standard Australia's accounting bodies set for valuation work. We are an independent valuation practice, not an accounting firm, and we hold every report we sign to it. The standard is theirs. The discipline is ours.

In practice that means a written engagement setting out the scope before we start, a fee that does not depend on the value we reach, a documented basis for every conclusion, and a report that discloses what we relied on and what we did not test. Every valuation is prepared by a suitably qualified business valuer at Valuation Group.

How is your information kept confidential?

Your information stays confidential. Documents, financial information and discussions relating to your valuation are handled confidentially.

Documents come only through the private upload link on your matter, never by email and never through this website. Where the information is commercially sensitive, such as customer pricing or a sale your staff do not yet know about, we can sign a confidentiality undertaking before you share it. If a co-owner, manager or employee should not know a valuation is being prepared, tell us at the scoping call and we will deal only with you.

What does this look like in practice?

Three illustrative examples follow. They are composites written to show the reasoning on typical industrial matters. They are not client matters, and the businesses are fictional.