(Second of two parts)
[caption id="attachment_15901" align="alignleft" width="324" caption="Mario Zepponi, Matt Franklin and Joe Ciatti"][/caption]
Our previous article explored the asset valuation method as a means for determining a brand’s value. This article focuses on the cash-flow analysis method as a tool for measuring a brand’s value based on its operating performance and future income potential.
The asset valuation method places emphasis on the value of a brand’s tangible assets, which consist mainly of its cased goods and bulk wine. The cash-flow analysis method incorporates two commonly used valuation techniques: the income approach and the market approach.
Cash-flow analysis attempts to translate current and future prospective cash flows into a current value for the brand, using “discount rates” (income approach) and “market multiples” (market approach).
Successful wine brands tend to benefit from the cash flow analysis method, as the resulting value generally exceeds the sum of its components under the asset valuation approach. Cased goods and bulk wine inventories are a source of potential income in the short term, but contribute little toward the staying power of a brand.
It is the “intangible assets” – brand uniqueness, established sales channels, direct sales, wine club memberships and the capacity to maintain a high level of wine quality – that contribute to a brand’s perceived value on a “going concern” basis. This is the underlying premise behind a cash flow analysis valuation.
However, before using the cash flow valuation method for valuing a brand, the winery’s financial statements should be reviewed and, where appropriate, restated in order to provide an accurate representation of the true financial performance of the brand.
Regardless of the financial metric used to value a brand, certain financial statement adjustments may be necessary or appropriate. In general, the types of adjustments most commonly applied in a winery brand valuation fall into the following categories:
The ultimate goal of adjusting the financial statements is to present a financial picture that best depicts the normal operating performance of a brand in adherence to wine industry standards. Once the income stream of the brand has been adjusted, as described above, the cash flow valuation method can be applied to the brand using the income and market approaches.
The income approach relies on the economic principle of present value – that an asset’s worth is equal to the expected future benefits of ownership discounted to reflect the time value of money and the risk associated with the investment opportunity. By definition, present value requires two main assumptions: an income stream and an appropriate discount rate.
As discussed above, the income stream should be adjusted (via any appropriate adjustments to the financial statements) to reflect the true financial performance of the brand. Typically, the income stream is projected out for three to five years. Anticipated returns beyond this time period should be aggregated by estimating cash-out value – that is, the present value of future cash flows beyond the projected time period – and discounting this amount to present value terms.
The exact discount rate applied under the income approach is a subjective matter. The applicable discount rate depends largely on required rates of return for similar investments and risks associated with the cash flows of the brand.