“It is difficult to make predictions, especially about the future.”
– Yogi Berra (baseball player) or Niels Bohr (physicist)
Regardless of the source, yes, it is – which is why seeing “Please provide the financial projections in place, if any, as of the date of valuation” as part of an information request associated with a business valuation can exasperate the recipient. To the extent that projections even exist, a common reply takes the following form:
“We have them for _____ year(s). How many years do you want/need?”
Our response, in turn, depends upon the number of years for which projections are available.
While there is no prescribed or ‘correct’ number, it can vary based upon manyfactors, including:
- A company’s financial position as of the date of valuation;
- Management’s growth expectations for revenue and profit margins;
- Growth expectations for the market(s) in which the company competes; and
- Growth expectations for the economies (local, regional, national, and/or global) in which a company operates.
At the least, the forecast period should reflect the duration of a business cycle. While officially dated by the National Bureau of Economic Research (NBER), on a practical level, a business cycle represents the period covered by “a recession and the expansion that follows it (until the next recession begins)” and refers to the “fluctuating levels of economic activity over a period of time measured from the beginning of one recession to the beginning of the next.”
Although the components of a business cycle (expansion, peak, contraction, recession, trough, and recovery) may be relatively consistent, the timing is not.
Recessions and expansions are unpredictable and their lengths vary. For example, according to the NBER, the shortest U.S. expansion lasted only 10 months, from March 1919 to January 1920. The longest expansion lasted 120 months, or 10 years, from March 1991 to March 2001. The shortest recession on record lasted only 6 months, from January to July in 1980, while the longest recession was over 65 months, or 5 years. It lasted from October 1873 to March 1879 and is known as “The Long Depression.”
Overall, business cycles in the U.S. have “varied between one and 10 years.”
Given the historical unpredictability and variability, consider a forecast period of five years as a starting point – and then adjust the length to account for the factors cited above.
Regardless of the length of the forecast period, ensure that documentation (quantitative and qualitative) exists to support the data presented. Having it in place – and in a format ready to be shared when asked by your CFGI valuation professional – will allow the engagement to progress as smoothly as possible.
