I know there are growth assumptions built into the algorithm based on industry etc. Let's say industry X is 5%, but we put 10% growth in step 6.... will that be the difference of 5% or is that 10% on top of the assumed 5%?

The entry for the growth slider SHOULD be the expected long term growth rate - and on a standalone, company specific basis (NOT in addition to an assumed industry growth rate - just whatever the firm's expected growth rate is). Many users simply estimate the recent historical growth rate for revenues (and the EBITDA margin) and use this, but technically it is based on EXPECTED growth.

For the sake of historical perspective, the growth rate entry is currently combined with the EBITDA margin entry to determine whether or not a set of "high growth/high profit" multiples should be utilized (based on data obtained from Michael Moe and used by private equity/venture capital companies). It is ONLY when the two entries together are quite high that the value is actually impacted.

Best Practices for Determining Growth Rates

In addition to improving the quality of the estimate via the relationship between expected growth and business value, we can also upgrade the tips and instructions for this topic. Here are some "best practices" for determining growth projections under two scenarios (one for data entered into Step 3 and one related to Step 6 the "growth slider/EBITDA margin" entries). Formulas for compound annual growthrates are in the attachment.

Step 6 Entries

FIRST, when estimating long term growth rates, an entirely different mindset is required.  In most professional business appraisals utilizing discounted cash flow analysis, it is unusual to see a long term growth rate in excess of 5% due to the impact of compounding on business value. In addition, this "growth rate" applies to earnings or cash flows to shareholders and NOT to revenues. There may be several years of much higher growth, e.g. the next 3 to 5 years, but the "long term" growth rate in perpetuity is rarely over 5%. Startup an high growth companies are exceptional in this regard.

With respect to our "growth slider", a company’s LTG rate should be “determined by a number of subjective factors—the quality of management, the strength of a firm’s marketing, its capacity to form partnerships with other firms, and the management’s strategic vision, among many others.” Historical rates of growth may also be helpful. Importantly, estimates of future growth must be supported by actual and credible plans, e.g. new product, acquisition of competitor, new marketing plan and expenditures, etc.

Appraisers will also include reinvestment as a factor of a company’s expected long-term growth rate. For example, Damodaran writes that “defining reinvestment broadly to include acquisitions, research and development, and investments in marketing and distribution allows you to consider different ways in which firms can grow. For some firms like Cisco, reinvestment and growth come from acquisitions, while for other firms such as GE it may take the form of more traditional investments in plant and equipment.

Step 3 Entries

SECOND, with respect to projecting only the current year figures (now this is 2016) for entry into the Bizequity system there are a few caveats when using interim financial statements.

For example, let's say the advisor has interim financials (income statement) through the end of June (six months). The easiest (but almost assuredly incorrect) tactic would be to simply double every metric (revenues, pretax income, officer comp, int and non-cash charges). This is problematic due to three general reasons:

1) Most businesses are at least somewhat seasonal, with retail businesses an obvious example with a high preponderance of revenues and profits generated during November and December or holiday season. Simply doubling the revenues through June may materially understate or overstate total revenues (and then total profits, etc.). There are resources available which present typical monthly sales patterns for different types of businesses, e.g. a florist versus a restaurant, etc.

2) Expenses are not always recognized evenly throughout a given year.  Many interim income statements will not have any non-cash expenses recorded as they are year-end adjusting entries (even interest expense is handled like this in certain cases). Other expenses are "lumpy" and may fall to the income statement all at once, e.g. payment of an insurance policy all at once to obtain cash discount.

 3) Finally, business strategies and tactics change frequently and disrupt the expense recognition patterns as decisions are made in a given year. For example, a consultant may be hired or a new aggressive ad campaign may be planned or an expensive but ineffective employee may be terminated and replaced with a lower cost alternative. Naturally, these types of changes are not always known or predictable, but they should be considered when seeking to annualize current year financial results.