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How can you use historical performance to value a business?

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If you are looking to buy or sell a business, you need to have a reliable way of estimating its value. One of the most common methods is to use historical performance, which means looking at the past financial results and trends of the business. Historical performance can help you assess the profitability, growth, cash flow, and risk of the business, and compare it with similar businesses in the market. However, historical performance is not enough to value a business on its own. You also need to consider the future potential, the industry outlook, and the intangible assets of the business. In this article, we will explain how you can use historical performance to value a business, and what are the limitations and challenges of this method.

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Vitor Pess?a, CFA

M&A | Corporate Development
Patrick Dykmans Holm

Connecting dots and sharing knowlege for a greener future

1 What is historical performance?

Historical performance is the record of the financial performance of a business over a period of time, usually several years. It includes metrics such as revenue, earnings, margins, assets, liabilities, equity, cash flow, and return on investment. Historical performance can be found in the financial statements of the business, such as the income statement, the balance sheet, and the cash flow statement. Historical performance can also be adjusted for one-time events, non-recurring items, and accounting differences, to make it more comparable and consistent.

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2 Why is historical performance important?

Historical performance is important because it shows how the business has performed in the past, and how it has responded to changes in the market, the competition, and the customer demand. Historical performance can help you evaluate the strengths and weaknesses of the business, and identify the key drivers and risks of its profitability and growth. Historical performance can also help you benchmark the business against its peers, and determine its market position and competitive advantage. Historical performance can also provide a basis for projecting the future performance of the business, and estimating its cash flow and earnings potential.

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3 How to use historical performance to value a business?

In order to value a business using historical performance, you must apply a valuation method that uses historical financial data as an input. The market approach is one such method, where the business is compared to similar businesses that have been sold or traded in the market, and multiples such as price-to-earnings, price-to-sales, or enterprise value-to-EBITDA are used to estimate its value. The income approach discounts future cash flow or earnings of the business to the present value, and takes into account historical performance to estimate the growth rate, discount rate, and terminal value of the business. Lastly, the asset approach adds up the value of all assets and subtracts the value of all liabilities of the business, while adjusting book value of assets and liabilities to their fair market value based on historical performance.

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Vitor Pess?a, CFA

M&A | Corporate Development
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Usually, historical performance is used as baseline for future projections (e.g. Margins, Growth, Expenses, etc). Past performance do not guarantee future performance. However, they are a good proxy to start a financial model

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4 What are the limitations of historical performance?

Historical performance is not a foolproof indicator of the value of a business, as it does not take into account the future potential, industry outlook, and intangible assets. It can also be affected by accounting policies and practices which vary across businesses and industries, business cycles and seasonality which can cause fluctuations in performance over time, and external events and shocks which can significantly impact the financial performance of the business. All these factors together make it hard to compare and forecast the performance across different periods.

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5 How to overcome the challenges of historical performance?

To overcome the challenges of historical performance, you need to supplement it with other sources of information and analysis. Industry analysis can provide an understanding of the trends, opportunities, and threats in the industry and how they affect the demand, supply, and competition. Market analysis can assess the size, growth, and segmentation of the market and customers' preferences. SWOT analysis can determine the strengths, weaknesses, opportunities, and threats of the business and its influence on value proposition and competitive edge. Lastly, sensitivity analysis can help test assumptions and scenarios that underlie valuation methods and their effect on a business's value.

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6 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?

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Patrick Dykmans Holm

Connecting dots and sharing knowlege for a greener future
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Historical performance shows you the ability of management to carry on a plan. Rather than seeing it as a whole, you need to break it down as much as possible so that you know how much of that performance is depending on xyz product, manager or other variables. We use to run a management scenario so that they could know what could be their valuation if they were to reach those targets. In hindsight the ones that did reach the goal were the better managers with great advisors. So for me the story behind the performance from the past is what I analyze for the performance of the future.

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How can you use historical performance to value a business?

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1 What is historical performance?

2 Why is historical performance important?

3 How to use historical performance to value a business?

4 What are the limitations of historical performance?

5 How to overcome the challenges of historical performance?

6 Here’s what else to consider

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