How can you account for timing differences in the transaction approach?

1 Time value of money

Time value of money (TVM) is the idea that money today is worth more than money in the future, because money today can be invested and earn interest or returns over time. Therefore, when you compare transactions that happened at different dates, you need to account for the effects of inflation, interest rates, and market conditions on the value of money. For example, if a company was sold for $100 million in 2018 and another company was sold for $110 million in 2020, you cannot simply compare the two transactions based on the nominal values. You need to adjust them for the changes in the purchasing power of money over time.

2 Methods of adjusting for timing differences

There are two common methods of adjusting for timing differences in the transaction approach: the historical method and the forecast method. The historical method uses historical inflation rates or market indices to adjust the past transactions to the present value. For example, if the inflation rate was 2% per year from 2018 to 2020, you can multiply the $100 million transaction in 2018 by 1.02^2 to get the equivalent value in 2020, which is $104.04 million. Alternatively, you can use a market index, such as the S&P 500, to adjust the past transactions based on the changes in the market performance. For example, if the S&P 500 increased by 10% per year from 2018 to 2020, you can multiply the $100 million transaction in 2018 by 1.1^2 to get the equivalent value in 2020, which is $121 million.

The forecast method uses projected inflation rates or market growth rates to adjust the future transactions to the present value. For example, if you expect the inflation rate to be 3% per year from 2020 to 2022, you can divide the $110 million transaction in 2020 by 1.03^2 to get the equivalent value in 2018, which is $103.88 million. Alternatively, you can use a market growth rate, such as the expected return on equity (ROE), to adjust the future transactions based on the expected returns. For example, if you expect the ROE to be 12% per year from 2020 to 2022, you can divide the $110 million transaction in 2020 by 1.12^2 to get the equivalent value in 2018, which is $87.76 million.

3 Advantages and disadvantages of each method

Both methods have their advantages and disadvantages, depending on the availability and reliability of the data and the assumptions. The historical method is simpler and more objective, as it uses actual data from the past to adjust the transactions. However, it may not reflect the current or future market conditions, as it assumes that the past trends will continue in the same way. The forecast method is more forward-looking and flexible, as it uses projected data from the future to adjust the transactions. However, it may be more subjective and uncertain, as it relies on assumptions and estimates that may not be accurate or consistent.

Therefore, when you account for timing differences in the transaction approach, you need to choose the method that best suits your purpose and data availability. You also need to be aware of the limitations and uncertainties of each method and perform sensitivity analysis to test the impact of different scenarios and assumptions on your valuation multiples.

4 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?