Tag Archives | economy

Fair Market Value

Fair Market Value Definition

The Fair Market Value definition is the price a specific property, asset, or business would be purchased for in a sale. A company’s fair market value should be an accurate appraisal of its worth.

Calculating Fair Market Value is subject to the following conditions:

  1. Prospective buyers and sellers must be knowledgeable about the asset.
  2. Buyers and sellers must not be coerced or strong-armed into selling or purchasing.
  3. All parties must provide a reasonable time frame to complete the transaction.

In other words, an estimate of the amount of money an industry-educated, interested, unpressured buyer would pay to an industry-educated, interested, unpressured seller is the FMV.

How to Determine the Fair Market Value of Your Company

If you are considering selling your business in the future or are just trying to strategically plan for the long-term, determining the fair market value of your company is a crucial step. The difference between the fair market value and the purchase price can often be considerable; consequently, many sellers hire professional appraisers for business valuation. This cost can range from a few thousand dollars to $50,000; however, we highly recommend to hire a third party as most owners inaccurately estimate the value of their business, which can lead to disappointed expectations regarding the company’s value or a low sale that leaves hard-earned money on the table.

(Are you in the process of selling your company? The first thing to do is to identify “destroyers” that can impact your company’s value. Click here to download your free “Top 10 Destroyers of Value“.)

What Your Appraiser Will Look For

There are many ways to calculate the Fair Market Value of your business; some of the factors that affect a business’s FMV are the business type, the economic conditions at the desired time of sale, the book value, recent income, dividends, goodwill, and recent prices paid for comparable businesses. During an assessment of your company, an appraiser will look for the following items along with many others:

  1. Future Earnings: An appraiser will forecast future earnings over multiple years, factoring in the discount cash flow and discount residual value by comparing your company to similar ones. The discount rate reflects the diminishing value of money year after year. They will also determine the “capitalization of earnings rate,” which indicates the cost of capital and the company’s risk.
  2. Asset Assessment: They will evaluate the Fair Market Value of all the tangible assets of the company, such as inventory or equipment, as well as the intangible assets, such as brand, reputation, and location.
  3. Comparable Sales Figures: They will analyze recent sales of commensurate companies.
  4. A Partial Purchase Discount: If the buyer is purchasing a minority share of the company, less than 50%, apply a discount since the other party would still control the business.

Appraisers and valuation experts typically use more than one approach when evaluating the FMV of a company. So start identifying the value of your business today by grabbing your business tax returns and general ledger.

See Also:
Adjusted EBITDA
Asset Market Value vs Asset Book Value
Valuation Methods
Goodwill Impairment

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Fishing Below Economic Dams

Hoover DamPicture yourself fishing below a hydroelectric dam with 5 generators running. The water is flowing strong. I am fishing 200 yards below the dam and you are fishing 2 miles below. They just shut down two of the generators because they don’t have enough demand for electricity.

The water is still flowing but at a much slower pace. I feel it immediately and you don’t feel it for 6 or 7 hours.

Fishing Below Economic Dams

This is the scenario in Houston today! The oil industry has just had a 30% drop in commodity prices in the past 6 months because of oversupply and low demand. The activity level below our economic dam has just dropped. The industry is just beginning to react to the new environment. Companies are watching to see if the drop is temporary or longer term.

What is interesting is the public perception of what is going on. Depending on which industry you ask they feel the change to varying degrees. If you speak with someone in the E&P industry they are watching the change like a hawk. They are fishing 200 yards below the dam!

If you speak to someone in the real estate or construction industry they are, for the most part, “whistling past the grave yard” hoping that any fallout is brief. They are 2 miles below the dam!

Should you panic? Is it going to get worse? If I knew I would be sitting on a beach in Cabo.

I do think you should be making contingency plans. First, to deal with what fallout occurs at $75 per barrel oil. Second, what to do if it get’s worse! The thing to remember is that there is still water flowing.

What steps are you taking to manage the dropping water volume?

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Threat of New Entrants (one of Porter’s Five Forces)

See also:
Porter’s Five Forces of Competition
Supplier Power
Buyer Bargaining Power
Threat of Substitutes
Intensity of Rivalry
Complementors (Sixth Force)

Threat of New Entrants Definition

In Porters five forces, threat of new entrants refers to the threat new competitors pose to existing competitors in an industry. Therefore, a profitable industry will attract more competitors looking to achieve profits. If it is easy for these new entrants to enter the market – if entry barriers are low – then this poses a threat to the firms already competing in that market. More competition – or increased production capacity without concurrent increase in consumer demand – means less profit to go around. According to Porter’s 5 forces, threat of new entrants is one of the forces that shape the competitive structure of an industry. Thus, Porters threat of new entrants definition revolutionized the way people look at competition in an industry.

Threat of New Entrants Explanation

The threat of new entrants Porter created affects the competitive environment for the existing competitors and influences the ability of existing firms to achieve profitability. For example, a high threat of entry means new competitors are likely to be attracted to the profits of the industry and can enter the industry with ease. New competitors entering the marketplace can either  threaten or decrease the market share and profitability of existing competitors and may result in changes to existing product quality or price levels. An example of the threat of new entrants porter devised exists in the graphic design industry: there are very low barriers to entry.

As new competitors flood the marketplace, have a plan to react before it impacts your business. Download the External Analysis whitepaper to gain an advantage over competitors by overcoming obstacles and preparing to react to external forces, such as it being a buyer’s market. 

A high threat of new entrance can both make an industry more competitive and decrease profit potential for existing competitors. On the other hand, a low threat of entry makes an industry less competitive and increases profit potential for the existing firms. New entrants are deterred by barriers to entry.

Barriers to Entry

Several factors determine the degree of the threat of new entrants to an industry. Furthermore, many of these factors fall into the category of barriers to entry, or entry barriers. Barriers to entry are factors or conditions in the competitive environment of an industry that make it difficult for new businesses to begin operating in that market.

Examples of Barriers to Entry

A high production-profitability threshold requirement, or economy of scale, is an entry barrier that can lower the threat of entry. Highly differentiated products or well-known brand names are both barriers to entry that can lower the threat of new entrants. Significant upfront capital investments required to start a business can lower the threat of new entrants. Whereas, high consumer switching costs are a barrier to entry. When access to distribution channels is an entry barrier – if it is difficult to gain access to these channels, the threat of entry is low. Access to favorable locations, proprietary technology, or proprietary production material inputs also increase entry barriers and decrease the threat of entry.

And of course, if the opposite is true for any of these factors, barriers to entry are low and the threat of new entrants is high. For example, no required economies of scale, standardized or commoditized products, low initial capital investment requirements, low consumer switching costs, easy access to distribution channels, and no relevant advantages due to locale or proprietary assets all indicate that entry barriers are low and the threat of entry is high.

Other factors also influence the threat of new entrants. Expected retaliation of existing competitors and the existence of relevant government subsidies or policies can discourage new entrants. While no expected retaliation and the lack of relevant government subsidies or polices can encourage new entrants.

Threat of Entry Analysis

When analyzing a given industry, all of the aforementioned factors regarding the threat of new entrants may not apply. But some, if not many, certainly will. Of the factors that do apply, some may indicate a high threat of entry and some may indicate a low threat of entry. But, the results will not always be straightforward. Therefore it is necessary to consider the nuances of the analysis and the particular circumstances of the given firm and industry when using these data to evaluate the competitive structure and profit potential of a market.

High Threat of Entry of New Competitors When:

  • Profitability does not require economies of scale
  • Products are undifferentiated
  • Brand names are not well-known
  • Initial capital investment is low
  • Consumer switching costs are low
  • Accessing distribution channels is easy
  • Location is not an issue
  • Proprietary technology is not an issue
  • Proprietary materials is not an issue
  • Government policy is not an issue
  • Expected retaliation of existing firms is not an issue

Threat of New Entry is Low if:

  • Profitability requires economies of scale
  • Products are differentiated
  • Brand names are well-known
  • Initial capital investment is high
  • Consumer switching costs are high
  • Accessing distribution channels is difficult
  • Location is an issue
  • Proprietary technology is an issue
  • Proprietary materials is an issue
  • Government policy is an issue
  • Expected retaliation of existing firms is an issue

Threat of New Entry of competitors Interpretation

When conducting Porter’s 5 forces industry analysis, a low threat of new entrants makes an industry more attractive and increases profit potential for the firms already competing within that industry, while a high threat of new entrants makes an industry less attractive and decreases profit potential for the firms already competing within that industry. The threat of new entrants porter’s 5 forces explained is one of the factors to consider when analyzing the structural environment of an industry. To continue to expand your analysis, download the free External Analysis whitepaper by clicking here .

threat of new entrants

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threat of new entrants

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Supplier Power (one of Porter’s Five Forces)

See also:
Supplier Power Analysis
Porter’s Five Forces of Competition
Threat of New Entrants
Buyer Bargaining Power
Threat of Substitutes
Intensity of Rivalry

Supplier Power Definition

In Porter’s five forces, supplier power refers to the pressure suppliers can exert on businesses by raising prices, lowering quality, or reducing availability of their products. When analyzing supplier power, you conduct the industry analysis from the perspective of the industry firms, in this case referred to as the buyers. According to Porter’s 5 forces industry analysis framework, supplier power, or the bargaining power of suppliers, is one of the forces that shape the competitive structure of an industry.

The idea is that the bargaining power of the supplier in an industry affects the competitive environment for the buyer and influences the buyer’s ability to achieve profitability. Strong suppliers can pressure buyers by raising prices, lowering product quality, and reducing product availability. All of these things represent costs to the buyer. A strong supplier can make an industry more competitive and decrease profit potential for the buyer. On the other hand, a weak supplier, one who is at the mercy of the buyer in terms of quality and price, makes an industry less competitive and increases profit potential for the buyer.

Download the External Analysis whitepaper to gain an advantage over competitors by overcoming obstacles and preparing to react to external forces, such as it being a buyer’s market.

Supplier Power – Determining Factors

The supplier power Porter has studied includes several determining factors. If suppliers are concentrated compared to buyers – there are few suppliers and many buyers – supplier bargaining power is high. Conversely, if buyer switching costs – the cost of switching from one supplier’s product to another supplier’s product – are high, the bargaining power of suppliers is high. If suppliers can easily forward integrate – or begin to produce the buyer’s product themselves – supplier power is high. Supplier power is high if the buyer is not price sensitive and uneducated regarding the product. If the supplier’s product is highly differentiated, supplier bargaining power is high. The bargaining power of suppliers is high if the buyer does not represent a large portion of the supplier’s sales. If substitute products are unavailable in the marketplace, supplier power is high.

And of course, if the opposite is true for any of these factors, supplier power is low. For example, low supplier concentration, low switching costs, no threat of forward integration, more buyer price sensitivity, well-educated buyers, buyers that purchase large volumes of standardized products, and the availability of substitute products. Each of the four mentioned factors indicate that the supplier power Porter’s five forces emphasize is low. To help determine the level of supplier power in your industry, start by performing an external analysis. This tool will easily help you determine the level of all of Porter’s Five Forces. Download the free External Analysis whitepaper by clicking here or the image below.

supplier power

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supplier power

15

Buyer Bargaining Power (one of Porter’s Five Forces)

Buyer Power Definition

Porter’s Five Forces of buyer bargaining power refers to the pressure consumers can exert on businesses to get them to provide higher quality products, better customer service, and lower prices. When analyzing the bargaining power of buyers, the industry analysis is being conducted from the perspective of the seller. According to Porter’s 5 forces industry analysis framework, buyer power is one of the forces that shape the competitive structure of an industry.

(See the other Porter’s 5 forces of competition.)

The idea is that the bargaining power of buyers in an industry affects the competitive environment for the seller and influences the seller’s ability to achieve profitability. Strong buyers can pressure sellers to lower prices, improve product quality, and offer more and better services. All of these things represent costs to the seller. A strong buyer can make an industry more competitive and decrease profit potential for the seller. On the other hand, a weak buyer, one who is at the mercy of the seller in terms of quality and price, makes an industry less competitive and increases profit potential for the seller. The concept of buyer power Porter created has had a lasting effect in market theory.

Conducting an industry analysis can be overwhelming and confusing. Download the External Analysis whitepaper to gain an advantage over competitors by overcoming obstacles and preparing to react to external forces, such as it being a buyer’s market. 

Buyer Power – Determining Factors

Several factors determine Porter’s Five Forces buyer bargaining power. If buyers are concentrated compared to sellers – if there are few buyers and many sellers – buyer power is high. If switching costs – the cost of switching from one seller’s product to another seller’s product – are low, the bargain power of buyers is high. If buyers can easily backward integrate – or begin to produce the seller’s product themselves – the bargain power of customers is high. If the consumer is price sensitive and well-educated regarding the product, buyer power is high. If the customer purchases large volumes of standardized products from the seller, buyer bargaining power is high. If substitute products are available on the market, buyer power is high.

And of course, if the opposite is true for any of these factors, buyer bargaining power is low. For example, low buyer concentration, high switching costs, no threat of backward integration, less price sensitivity, uneducated consumers, consumers that purchase specialized products, and the absence of substitute products all indicate that buyer power is low.

Buyer Power – Analysis

When analyzing a given industry, all of the aforementioned factors regarding Porter’s 5 Forces buyers power may not apply. But some, if not many, certainly will. And of the factors that do apply, some may indicate high buyer bargaining power and some may indicate low buyer bargaining power. The results will not always be straightforward. Therefore, it is necessary to consider the nuances of the analysis and the particular circumstances of the given firm and industry when using these data to evaluate the competitive structure and profit potential of a market.

Buyer Power is High/Strong if:

• Buyers are more concentrated than sellers

• Buyer switching costs are low

• Threat of backward integration is high

• Buyer is price sensitive

• Buyer is well-educated regarding the product

• Buyer purchases product in high volume

• Buyer purchases comprise large portion of seller sales

• Product is undifferentiated

• Substitutes are available

Buyer Power is Low/Weak if:

• Buyers are less concentrated than sellers

• Buyer switching costs are high

• Threat of backward integration is low

• Buyer is not price sensitive

• Buyer is uneducated regarding the product

• Product is highly differentiated

• Buyer purchases product in low volume

• Substitutes are unavailable

• Buyer purchases comprise small portion of seller sales

Buyer Bargaining Power Interpretation

When conducting Porter’s 5 forces buyer power industry analysis, low buyer bargaining power makes an industry more attractive and increases profit potential for the seller, while high buyer bargaining power makes an industry less attractive and decreases profit potential for the seller. Buyer power is one of the factors to consider when analyzing the structural environment of an industry using Porter’s 5 forces framework. The buyer power Porter’s five forces laid out is well respected even to this day.

Start preparing your external analysis so you can react in realtime when the buyer’s have bargaining power over your company. Don’t loose out because of an external force. Download the free External Analysis whitepaper by clicking here or the image below.

buyer bargaining power

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Click here to access your Execution Plan. Not a Lab Member?

Click here to learn more about SCFO Labs

buyer bargaining power

19

Where are Oil & Gas Prices Headed?

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We are attending the Nortstar Private Equity Fast Pitch conference. The keynote speaker was Marshall Adkins with Raymond James. Below are the highlights:

– the fundamentals for oil prices are trending down

– global demand is declining and supply is increasing

– oil prices may decline to $80-$85 bbls

– gas prices should increase to )4-$5 mcf ; less drilling for oil should result in less gas supply

– these price should occur in 2014

– vehicle miles travelled is falling because of three trends; shrinking demographics ( Baby Boomers retiring); increased urbanization ; rising Internet sales .

– therefore gasoline demand has decreased 8% over the past 5 years

Everyone else is optimistic about rising oil prices. All I know is “trees don’t grow to the sky!”

 

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Economic Trends for 2013

Today I attended a presentation by BBVA Research’s Chief US Economist, Nathaniel Kerp, in which he discussed economic trends in the US for 2013.

The overall theme is that the Federal Reserve is trying to convince the public to take risks. I am not sure that is a good idea. Warren Buffet has said that most people borrow money in the good times and try to pay it back in the bad times when their income is reduced. He says you should do the opposite. Borrow money when times are bad and pay it back as the economy recovers. My question is have we missed the window for the time to borrow?

Below are some other interesting economic trends:
* US exports are greater than US investments.
* The top three concerns for small business is Taxes, Regulation and Sales, in that order.
* The US Personal Debt to Income Ratio is back to it’s long term trend line.
* Can’t have inflation with high unemployment and limited wage growth. ( no surprise there, but, good to be reminded.
* The Federal Reserve should start raising the fed fund rate in July 2015
* therefore. Lower interest rates for 2013 and 2014
* according to the World Economic Forum the US has dropped in it’s Global Competition Ranking from 2nd in 2009 to 7th in 2012.

My final comment, Is this the time to invest in the stock market? If the Fed’s liquidity drives stock prices up , then when they reverse direction ( which they will) will stocks drop?

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