How changes to financial reporting could impact your business valuation

Proposed changes to accounting standards could significantly impact the technical valuation of your business.

FRS 102 is the Financial Reporting Standard applicable in the UK and the Republic of Ireland, and periodically it comes under review. Proposed amendments put forward following the latest review include the introduction of a new model of revenue recognition and a new procedure regarding accounting for leases.

If these changes are implemented and you are selling your business, there will be several matters to consider, including:

Revenue recognition changes

This change could potentially affect your firm’s overall turnover due to revenue not being recognised until some contracts are completed, rather than being recognised over time. This will lead to a decrease in a company’s maintainable EBITDA which is used in the earnings multiple method of valuing a business, leading to an overall decrease in enterprise value.

Lease accounting changes

The new procedure for lease accounting could potentially affect your firm’s value in two ways:

  1. the change of operating lease costs, such as rent being recognised as depreciation rather than rental costs, will increase a company’s maintainable EBITDA and increase the enterprise value of the business.
  2. when recognising the whole of the lease onto the balance sheet at the start of the contract, instead of recognising it as an expense over the life of the lease, this will increase debt value when making a technical ‘cash free debt free’ adjustment reducing the equity value of the business.

Until the changes are confirmed, the full impact on the valuation of a business is unknown, however, this does provide food for thought, as should the proposed changes be introduced and no adjustments made to the method of the valuation, incorrect values may be paid or received.  It would therefore be important for those looking to buy or sell businesses to engage with an adviser who fully understands the implications and options, and can potentially use that knowledge to your advantage.

This article was written by ALFMA member Armstrong Watson. ALFMA members can be contacted here.

Read more about how the changes to financial reporting could impact the value of your business.