Manufacturing business valuation

What makes a manufacturing business different to value?

Manufacturing covers a lot of ground. The Australian and New Zealand Standard Industrial Classification (ANZSIC) splits it into 15 subdivisions, from food product manufacturing through fabricated metal products, polymer and rubber products and machinery and equipment to furniture. A bakery supplying supermarkets, a CNC job shop and a plastics moulder share a label, but very little else when it comes to value.

What they do share is a business built on physical capacity. A manufacturer buys inputs, converts them with plant and labour, holds stock at several stages and sells on credit. That creates four things a generic valuation tends to underweight: the capital needed to keep the plant productive, the cash tied up between raw material and receipt, dependence on a few customers, and the handful of people who know how the processes really run.

How the operating model changes the analysis

Most private manufacturers sit in more than one row. A company that makes its own range of trailers and also does contract fabrication has two businesses inside one set of accounts, and they rarely deserve the same treatment. We separate them where the numbers allow, then put them back together. Specialist sectors have their own guides: food manufacturing, packaging, fabrication and defence and specialist manufacturing.

Which valuation methods suit a manufacturer?

The method follows the business. For a profitable, established manufacturer the usual primary method is capitalisation of maintainable earnings: work out the earnings a buyer could reasonably expect to sustain, then capitalise them at a rate that reflects the risk. Our methodology page explains each approach in full. Here is how they apply on a factory floor.

• Capitalisation of maintainable earnings suits a manufacturer with a stable trading history and a plant that is not about to need a major reinvestment.
• Discounted cash flow comes in when the future will look materially different from the past: a new production line being commissioned, a major contract starting or ending, or a large capex program ahead.
• Asset-based approaches matter where earnings do not support the value of the net assets, which happens more often in manufacturing than owners expect. A business earning a thin return on a large plant may be worth closer to what its assets would realise.
• Market evidence from transactions is a cross-check where reliable comparable information exists. Private manufacturing sales are rarely disclosed in useful detail, so we treat it with care.

We usually run more than one approach and reconcile them. If the earnings-based value falls well below the net tangible assets, that tells us something about the business, and the report says what.

How do we work out maintainable earnings?

Maintainable earnings are the earnings a new owner could expect to keep in a normal year. We usually start from three years of accounts plus the current year to date, and work through the adjustments one at a time. The ones that come up most in manufacturing:

• Owner remuneration. We replace what the owners draw with the market cost of the roles they perform. An owner who runs production and quotes every job may be doing the work of two salaried managers.
• Related-party rent. Many manufacturers operate from a factory owned by the owners' super fund or family trust. If the rent is above or below market, we restate it.
• Stocktake and inventory adjustments. A year-end count that was not done properly, or obsolete stock written off in one hit, distorts gross margin from year to year. We look at margins month by month to see the real pattern.
• One-off items. Insurance recoveries, a lease dispute, a factory relocation, a single large order that will not repeat. Each needs evidence before it comes out.
• Family members on the payroll. Wages paid to people who do not work in the business are added back. Wages for family members who do real work, often below market, are restated upward.
• Leases. Under AASB 16 Leases, most leases sit on the balance sheet and rent moves out of EBITDA; some smaller companies still expense it. We put earnings and debt on the same basis before comparing anything.

We also decide which earnings line to value. EBITDA is a common reference point, but in a capital-intensive manufacturer it overstates what a buyer can take out of the business, because it ignores the plant wearing out. That is why we often value on EBIT, or on EBITDA less sustaining capex. Our article on EBITDA versus EBIT covers the difference in more detail.

What moves the multiple for a manufacturing business?

Owners often ask what multiple manufacturing businesses sell for. We do not publish a number, because one figure would have to cover a bakery, a CNC job shop and a plastics moulder at once. Buyers price what sits behind the earnings, and they price it carefully. These are the factors that push a multiple up or down.

Multiples quoted in the press or by brokers also mix definitions. Some are on EBITDA and some on EBIT, some are before owner salaries, some include stock and working capital and some do not. Comparing your business with a headline number is risky unless you know exactly how it was built. Our article on manufacturing valuation multiples explains how to read them.

How does plant and equipment affect the value?

A factory full of machines is not the same as a factory full of value. In a going-concern valuation the machines are already working to produce the earnings, so their value is captured in the earnings. Adding the written-down value of the plant on top would count it twice.

Equipment changes the value in other ways:

• Age and condition set the capex a buyer must fund. A five-axis machining centre bought last year and a row of 25-year-old manual lathes both make parts, but only one comes with a replacement bill.
• Surplus assets are treated differently. Machines that are not needed to produce the earnings, such as an idle press line, a spare forklift fleet or land held for expansion, can be added to the earnings-based value at what they would realise.
• Finance reduces the value of the shares. Chattel mortgages, hire purchase and finance leases are debt, and a buyer deducts them from the price.
• Specialised equipment cuts both ways. It may be the reason customers come to you, and it may be worth little on the second-hand market if the business ever has to close.

We value the business, not the individual machines. A formal plant and machinery valuation, for finance, insurance or a sale of assets, is a separate discipline carried out by a plant and machinery valuer. Where a recent one exists we can use it as an input, particularly for surplus assets or an asset-based cross-check. Our article on plant and equipment in a business valuation goes further.

Working capital, inventory and work in progress

A manufacturer funds raw materials, work in progress and finished goods, then waits for its customers to pay. That working capital is part of the operating business. When a manufacturer is sold, the price normally assumes a normal level of working capital comes with it, and the amount is adjusted at completion if the actual level is higher or lower.

Setting the normal level is where manufacturing gets technical:

• Monthly balances, not the year-end. Many manufacturers carry more stock at 30 June than at any other time of year, or much less. An average of 12 or 24 month-end balances gives a fairer picture.
• Test the stock. Under AASB 102 Inventories, stock is carried at the lower of cost and net realisable value. Slow-moving raw materials, finished goods for discontinued lines and packaging for products no longer made often sit on the books at cost. A stock ageing report usually finds them.
• Check how WIP is costed. Work in progress is often an estimate: hours on the job card plus materials issued, sometimes with overheads absorbed at a rate set years ago. Overstated WIP inflates profit in the year it is booked and reverses later.
• Look at terms on both sides. A major customer moving from 30 to 90 day terms can absorb hundreds of thousands of dollars of cash with no change in profit. Suppliers tightening their terms has the same effect.

More detail is in our article on working capital in a manufacturing valuation.

Why capex matters more than owners expect

Deferred capex does not disappear. It moves from the seller's accounts into the buyer's price.

We split capex into two kinds. Sustaining capex keeps the existing plant producing at its current level: replacing worn machines, rebuilding a press, upgrading a compressor, keeping forklifts and tooling serviceable. Growth capex adds capacity or capability: a second machining centre, an automated cell, a new product line. Sustaining capex is a real cost of earning today's profit and comes off the value. Growth capex is optional, and it belongs with the growth it pays for.

Owners planning a sale sometimes hold back on capex for a few years. Profits look better, the plant gets older, and the buyer's engineer notices. We compare the capex history with depreciation and the asset register, and ask what the plant will need over the next three to five years. Tax depreciation is a poor guide: machines are often written off for tax long before they stop working.

How does customer concentration affect a manufacturer?

A manufacturer selling 45% of its output to one customer carries a different risk from one with 80 active accounts. The question is not only how big the customer is, but what holds the relationship in place.

• Supply agreements with a term, a pricing mechanism and volume commitments are worth more than purchase orders. Read the termination and change-of-control clauses: some let the customer walk away if the business is sold.
• Qualification costs protect the incumbent. If a customer would have to requalify parts, run trials or re-audit a new supplier, switching is expensive and slow.
• Customer-owned tooling can tie the customer to you, or make it easy to move the dies and moulds to a competitor. Who owns the tooling, and what the agreement says about it, matters.
• Pricing power shows in the history. Did the business pass on the steel, resin, energy and wage increases of recent years, or absorb them?

We ask for revenue by customer for at least three years so we can see concentration, churn and the trend in each major account. Our article on customer concentration explains how we weigh it.

Labour, skills and the owner

Labour is usually a manufacturer's largest controllable cost, and skills shortages make it a value issue as well. Many factory employees are covered by the Manufacturing and Associated Industries and Occupations Award 2020 (MA000010); others by an enterprise agreement or an industry-specific award. We look at how wages are set, overtime as a share of total hours, reliance on labour hire, and the accrued annual and long service leave a buyer would take on with the staff.

The harder question is who holds the knowledge. In many private manufacturers the owner is the chief estimator, the production planner and the person every major customer rings. A few long-serving tradespeople know how to set up the older machines and keep them running. If those people leave, part of the earnings may leave with them.

Buyers discount for this, often by deferring part of the price or requiring the owner to stay through a handover. An owner who has built a second tier of management and introduced customers to other staff usually sees it in the price.

Succession: family, management or an outside buyer

Many manufacturing owners are planning succession, and the valuation question changes with the exit route. A trade buyer may see savings it will not pay you for, though competition between buyers can lift the price. A sale to management or family is often funded from the business's own cash flow over several years, so the price has to be one the business can actually carry. A transfer within a family may also need a market value at a specific date for tax purposes.

A valuation two or three years before an exit is often more useful than one at the point of sale. It shows what is dragging the value down while there is still time to fix it: an undocumented quoting process, a lease with no options left, a customer that has drifted to half of sales. Our succession and estate valuation page covers the planning side, and business sale valuations the sale itself.

What risks do we look for in a manufacturing business?

• Input cost exposure. Steel, aluminium, resin, board, ingredients and energy move with global markets and the Australian dollar. We look for pass-through clauses and the lag before price increases take effect.
• Import competition. Products that can be made offshore and shipped in face constant price pressure. Products that are heavy, bulky, made to order or needed quickly are better protected.
• Site and lease. A plant with heavy foundations, overhead cranes, large power supply or trade waste approvals is costly to move. The lease term and options remaining matter, and so does what happens if the landlord sells.
• Environmental and regulatory. Licences for emissions or trade waste, contaminated land, dangerous goods storage and product compliance obligations can carry costs a buyer will want resolved before completion.
• Product liability. Warranty claims, recall exposure and insurance cover, especially for products used in vehicles, buildings or food.
• Cyclical end markets. Manufacturers supplying construction, mining or agriculture ride those cycles. We look at how the business performed in the last downturn, not only in the last good year.

What does a manufacturing valuation framework look like?

Every manufacturer is different, but the work follows a consistent sequence. The illustrative example on this page shows the earnings side for a hypothetical business. It stops before the capitalisation step, because the rate applied depends on a full risk assessment, not a rule of thumb.

1. Understand the business: products, customers, plant, people and how the work is won.
2. Normalise three to four years of earnings and identify a maintainable level.
3. Assess sustaining capex against the asset register and the condition of the plant.
4. Set the normal level of working capital from monthly balances.
5. Assess risk: concentration, owner dependency, capacity, margins and industry conditions.
6. Apply the primary method and cross-check it with a second approach.
7. Adjust for surplus assets, debt and debt-like items to reach the value of the equity.
8. Explain the conclusion and the key judgements in plain English in the report.

What we need, and what changes the fee

The documents we usually ask for are listed on this page. You do not need all of them before we talk. Once we are engaged, documents come through the private upload link on your matter, never by email. Your information stays confidential, and we can sign a confidentiality undertaking before sensitive documents are shared.

Most manufacturing valuations are completed from documents and conversations with the owners. If the plant or the operation needs to be seen, we say so when scoping and agree any visit and its cost before we start.

The fee is fixed and set by annual turnover; the bands and delivery times are in the fee table below and on our pricing page. For a manufacturer, what most often changes the scope is structure. When the factory or the plant sits in a family trust or a second company, each additional entity is $795 + GST, and a second valuation date for a restructure or a shareholder exit is $495 + GST. We confirm the fee in writing before we start. No hourly billing. If you have a deadline, call 0433 475 518 (Mon to Fri, 9am to 5:30pm AEST).