Valued Customers: To What Extent Can the Worth of Customer Relationships Be Measured from the Point of View of Investors and Other Stakeholders? John White Offers a Basic Model for Use in Mergers, Acquisitions and Divestments. (Finance: Valuation)
White, John, Financial Management (UK)
John Sidgmore is the man with the task of cleaning out the Stygian accounting stables left behind by WorldCom's flamboyant founder, Bernie Ebbers. Announcing the largest Chapter 11 filing in US history, the company's new CEO was quoted as saying: "Our value is not in the switches and the underground pipes, but in 20 million customers."
From a statutory reporting perspective this is clearly a non-starter. Customers can, and frequently do, walk away. From a management accounting perspective, however, his statement is worth examining. A company's customer base is often the most significant factor in deciding its value in mergers and acquisitions. The value put on a firm, based on the time-honoured "how much someone is prepared to pay for it" method, therefore forms a key part of that most controversial of balance sheet items: goodwill.
If an asset is valued on the basis of its potential for future income, then a realistic assessment of goodwill should be based on a heavily quantified forecast of future revenues from customers. Taking a conservative stance, you could argue that the only customers who should be be considered are those with whom contracts are in place. And, of course, it is only the profit contribution from these contracts that should be assessed--never forget the small matter of fulfilling your own outstanding commitments under these contracts.
In practice, goodwill is always assessed on more than this. To arrive at a realistic price for the shares of a business in the event of an acquisition, there are many issues for prospective purchasers to consider. For example:
* What is the forecast cash flow (discounted as appropriate), and how much confidence do you have in that forecast?
* What are the key forecast ratios, particularly profit/earnings and profit/turnover?
* Will the acquisition result in a dilution of earnings per share?
The model above offers a method of assessing the overall value of a business's customer relationships. You should be able to obtain the
data required for the model from market research, sales forecasts and customer relationship management systems.
A number of questions need to be asked. Their significance will vary greatly, depending on the industrial sector and geodemographie factors, among others. They should include:
* What proportion of revenue derives from past and current customers compared with new business?
* How wide is the spread of customers in terms of current annual revenue, potential annual revenue, profitability etc? …