Sunday, September 24

Press Release: September 14, 2004

GAR Associates, Inc.

Press Release:   September 14, 2004

 

  GAR Associates, Inc. Establishes A More Reliable Methodology

For Use in Business Valuations

 

Amherst, NY - GAR Associates, Inc., recognized as a leading real estate appraisal and consulting firm in the Western New York area, announces a significant contribution to the field of business valuation.

 

Franz H. Ross, CBA, authored a study, which tests the level of correlation between 780 business sale transactions and ten different variables.   The study was published in the September 2004 issue of Shannon Pratt’s Business Valuation Update, one of the most widely recognized journals in the field of business valuation.   The study is titled: “Just One Thing”:   The Most Reliable Variable For Use In The Market Approach.

 

Mr. Ross’ hypothesis, that gross profit has the highest correlation to value for five broad lines of business, was presented and proven using measurements of statistical correlation.   The study included 780 transactions involving businesses with $1 Million to $30 Million in sales, which were grouped into the following five broad sectors:   wholesale, retail, manufacturing, construction, and printing.  

 

Mr. Ross commented, “It was surprising to me that I could not find a single text or article that even mentioned consideration of gross profit as a unit of comparison.   Our recommended process is not only more reliable statistically, but has the added advantage of using a relatively simple multiplier (gross profit).”

 

 “Furthermore, since gross profit is near the “top line” of an income statement, it provides a legitimate check of a near-bottom-line capitalized value obtained in the income approach.   Traditional valuation methodology generally involves using a near-bottom-line number in both the market and income approaches (garbage-in-garbage-out!), or using the substantially inferior net sales multiplier.”

 

Mr. Ross added, “While I was not surprised that my hypothesis was true, several other aspects of the study were very unexpected.”   Mr. Ross outlined these findings as follows:

 

The strength of the correlation between gross profit and business value was R = 0.91, for five broad groups (after eliminating outliers).   Perfect correlation is 1.00.   The tougher measure of R2 was also strong, at 0.82.   Considering the breadth of the data, this is an impressive correlation.

 

Gross profit (after elimination of outliers) was found to be a substantially superior measure.   The next best measure was “discretionary earnings” (defined as cash flow plus one owner’s salary and benefits), which had a final value of R2 = 0.74.   This more complex measure was also found to be inferior, as it was only available in 32% of the data, while gross profit was available in 97% of the transactions.   The third best measure was net sales, with a final value of R2 = 0.56.

 

Evidently, no statistical study measuring the reliability of various possible units of comparison has been published before.  

 

The President of GAR Associates, Inc., Walter R. Allen, SRPA, commented, “This study clearly represents a concrete addition to business appraisal knowledge, and we are confident that Franz’s study will improve the reliability of business valuations by appraisers who employ the new recommended methodology.”  

 

Though known primarily as a real estate appraisal firm, GAR Associates, Inc. has appraised business assets worth up to $200 Million.   For a copy of the article, “Just One Thing”:   The Most Reliable Variable For Use In The Market Approach, contact Franz at (716) 691-7100 Ext. 3040, or e-mail Franz @ fross@garappraisal.com.

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