Title: Understanding Going‑Concern Value — What It Is, Why It Matters, and How to Estimate It
Key takeaways
– Going‑concern value is the value of a business as an operating entity — including its ability to generate future profits and the value of intangible assets — and is typically higher than the value of its assets if sold off.
– The gap between going‑concern value and liquidation value is often recorded as goodwill and reflects intangibles such as brand, customer relationships, and patents.
– Valuation methods commonly used to estimate going‑concern value include discounted cash flow (DCF), market/comparable approaches, and income or capitalization approaches; the choice depends on the business and purpose of the valuation.
– Auditors and accountants generally assume a company is a going concern unless evidence suggests otherwise; if doubt exists, disclosures and additional evaluation are required.
What is going‑concern value?
Going‑concern value is the total worth of a business as an ongoing operation — not just the sum of its sellable assets. It captures the present value of expected future earnings, plus the value attributable to intangible assets and operational continuity (customer lists, brand reputation, supplier relationships, processes, trained staff, etc.). In most cases, a functioning company’s going‑concern value exceeds what the same assets would fetch in a forced or orderly liquidation.
How going‑concern value works: components and drivers
– Tangible assets: plant, equipment, inventory, real estate — useful to both going concern and liquidation valuations.
– Intangible assets and franchise benefits: brands, trademarks, patents, proprietary processes, customer relationships, and know‑how that create future cash flows and competitive advantages.
– Future earning potential: expected profits, cash flows, growth prospects, and synergies (e.g., cost savings or revenue gains from combining businesses).
– Market position and reputation: customer loyalty, supplier terms, and other operating advantages that would be lost or diminished on liquidation.
– Operational continuity: trained workforce and ongoing contracts that facilitate future revenue generation.
Going‑concern value vs. liquidation value
– Going‑concern value: assumes the business continues operating and earning future profits. Valuation reflects intangible assets and the value of continued operations.
– Liquidation value: estimates proceeds if the business’s assets were sold off and operations ceased. Often lower than book value because fire‑sales, transaction costs, and the loss of intangible value reduce recoverable amounts.
– Use cases:
– Going‑concern value is used for mergers and acquisitions, investment decisions, and strategic planning.
– Liquidation value is used when management or investors conclude that continued operations are unlikely or when winding up a business.
Goodwill and the difference between the two values
– The excess paid above the net fair value of identifiable assets and liabilities in an acquisition is recorded as goodwill. That excess captures intangibles and future earning potential not separately identifiable on the balance sheet.
– Goodwill is typically tested for impairment under accounting rules rather than amortized (subject to the applicable standards).
Accounting and audit considerations
– Going‑concern assumption: Financial statements are usually prepared under the assumption that a company will continue in operation for the foreseeable future. Auditors evaluate whether there is substantial doubt about a company’s ability to continue as a going concern for a specified future period (commonly 12 months from the date the financial statements are issued).
– Disclosure: If significant doubt exists, management must disclose conditions and plans to mitigate the uncertainty; auditors must consider the adequacy of those disclosures.
– Impairment and valuation: Acquired goodwill and certain intangible assets must be assessed periodically for impairment if there are indications that carrying amounts may not be recoverable.
Valuation approaches to estimate going‑concern value
1. Discounted Cash Flow (DCF) / Income approach
– Project expected future cash flows and discount them to present value using an appropriate discount rate (reflecting business risk and capital structure).
– Most appropriate when reliable projections and reasonable estimates of discount rates are available.
2. Market (comparable) approach
– Use recent transaction multiples (e.g., EV/EBITDA, price/earnings) from comparable companies or deals and apply to the subject business.
– Useful when there is a reasonably active market for similar businesses.
3. Asset‑based approach (adjusted book value)
– Start from fair value of net assets (tangible and identifiable intangible assets). This approach by itself may understate going‑concern value because it can omit intangible future earnings.
– Often used as a floor (minimum value) or in distressed situations.
4. Excess earnings / relief from royalty methods
– Methods that explicitly value intangible assets (e.g., customer relationships, trademarks) by allocating earnings to them and discounting.
Practical steps — How to estimate or improve going‑concern value
For business owners preparing for valuation or sale:
1. Prepare clean, well‑documented financial statements and forecasts
– Produce at least 3–5 years of historical financials and a detailed 3–5 year forecast with supporting assumptions.
2. Identify and document intangible assets and revenue drivers
– List patents, trademarks, key contracts, customer retention metrics, and supplier agreements; quantify contribution to revenue where possible.
3. Improve profitability and recurring revenue
– Focus on margin expansion, recurring revenue streams (subscriptions, service contracts), and reducing customer churn.
4. Strengthen governance and contracts
– Put key relationships and processes into documented contracts to reduce buyer perceived execution risk.
5. Benchmark and build comparables
– Gather data on comparable transactions and public company multiples to support a market approach.
For buyers and investors evaluating a target:
1. Use multiple valuation methods
– Cross‑check DCF results with market multiples and adjusted asset values to form a reasoned range.
2. Stress‑test assumptions
– Run downside scenarios, sensitivity analyses, and consider integration and execution risks.
3. Explicitly value intangible assets and synergies
– Quantify expected synergies or the impact of losing key intangibles if integration fails.
4. Compare to liquidation value as a floor
– Calculate liquidation proceeds to understand downside and the minimum recoverable value.
For accountants and auditors assessing going‑concern:
1. Evaluate indicators of financial distress
– Persistent losses, negative working capital, default on debt, inability to obtain financing, or adverse legal events.
2. Request management’s plans
– Management should provide plans to mitigate going‑concern risks (cost reductions, asset sales, new financing).
3. Consider adequacy of disclosures and possible audit opinion implications
– When substantial doubt exists, enhanced disclosures are required and may affect auditor reporting.
Fast facts
– Typically, going‑concern value > liquidation value because going concern captures intangible value and future earnings.
– Liquidation proceeds may be materially lower than book value due to forced sale discounts and transaction costs.
– Most companies are presumed to be going concerns; the presumption is overturned only when credible evidence suggests imminent cessation of operations.
Worked example (simplified)
– Suppose a manufacturer, “Alpha Widgets,” has net realizable tangible assets worth $8 million if sold quickly (liquidation value). If Alpha has steady customers, recognized brand, and patented processes that support projected free cash flows worth $40 million in present value, then:
– Liquidation value = $8 million
– Going‑concern value ≈ $40 million
– Implied goodwill or intangible premium = $32 million
– A buyer paying near the going‑concern value is pricing the future earnings and intangibles, not just the physical assets.
Limitations and risks
– Going‑concern valuations are sensitive to forecasting errors, discount rate selection, and assumptions about market conditions and synergy realization.
– Overstating intangible value or future growth can lead to overpayment and later impairment losses.
– Liquidation value may be appropriate in distressed situations, but using it when a business is viable can destroy value and reputation.
References and further reading
– Investopedia — “Going‑Concern Value” (source for concept overview): https://www.investopedia.com/terms/g/going_concern_value.asp
– AICPA AU‑C Section 570, “The Auditor’s Consideration of an Entity’s Ability to Continue as a Going Concern” (audit guidance)
– IAS 1 — Presentation of Financial Statements (IFRS requirements for going concern assessment)
If you’d like, I can:
– Build a simple DCF template you can use to estimate going‑concern value, or
– Walk through a valuation of a specific company with your financials and assumptions. Which would you prefer?