Intangible assets, like brand names, customer relationships, and computer software, often represent a significant portion of a company’s value. Accurately valuing these assets is necessary for various purposes, with IFRS 3 purchase price allocations in financial reporting being one of the most important. One widely used method for valuing certain intangible assets is the Multi-Period Excess Earnings Method (“MPEEM”). The MPEEM focuses on the future economic benefits an intangible asset is expected to generate. It calculates the present value of these future cash flows, providing an estimate of the asset’s worth. MPEEM is particularly relevant when the intangible asset being valued is the primary intangible asset of the business. In such cases, this key intangible is valued using MPEEM, while other, less significant intangibles may be valued using different approaches. It’s also the most common method for valuing customer-related intangible assets.
How MPEEM Works for Customer Relationships:
When applied to customer relationships, MPEEM considers the present value of the cash flows attributable to those relationships. This involves several key steps:
- Forecasting Future Cash Flows: The method projects the future revenue generated from the existing customer base. This requires analysing historical data, market trends, and other relevant factors to estimate future sales and profitability.
- Adjusting for Attrition: Customer relationships do not remain indefinitely. The MPEEM method incorporates an adjustment for customer attrition, which reflects the expected rate at which customers no longer likely to return. This adjustment reduces the projected cash flows to more accurately represent the realistic duration of customer relationships.
- Considering Contributory Assets: Customer relationships rarely exist in isolation. They often rely on other assets, known as contributory assets, to generate cash flows. These can include:
- Working Capital: The funds needed to support sales to customers (e.g., inventory, accounts receivable).
- Fixed Assets: Property, plant, and equipment used to produce goods or services for customers.
- Assembled Workforce: The skilled employees who interact with and serve customers.
- Other Intangibles: Other intangible assets that support customer relationships, such as brand reputation or technology. MPEEM subtracts the returns attributable to these contributory assets from the overall cash flows generated by the customer relationships. This isolates the excess earnings specifically attributable to the customer relationships themselves.
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Discounting to Present Value: Finally, the future excess cash flows, adjusted for attrition and contributory assets, are discounted to their present value, reflecting the time value of money. The discount rate applied corresponds to the risk associated with the projected cash flows.
MPEEM offers numerous advantages for intangible asset valuation. By focusing on the future economic benefits an asset is projected to generate, it provides a more realistic valuation than methods relying solely on historical costs. The method is also widely recognised and accepted, particularly for valuing customer-related intangibles. Its comprehensive approach incorporates key factors like customer attrition and the contributions of supporting assets, leading to a more nuanced and potentially accurate valuation. However, MPEEM also has limitations. Its reliance on future cash flow projections introduces subjectivity and uncertainty, as the accuracy of the valuation hinges on the reliability of these forecasts. Furthermore, the method’s complexity often necessitates specialised expertise and can be data-intensive, requiring substantial information such as historical sales, customer attrition rates, and detailed data on contributory assets, which may be difficult to obtain.
Overall, MPEEM is a valuable tool for valuing a company’s primary intangible asset, particularly customer relationships. By focusing on the future economic benefits and considering relevant factors like attrition and contributory assets, it provides a more comprehensive valuation than simpler methods. When applied correctly, MPEEM can provide a defensible valuation of key intangible assets necessary for accurate and transparent financial reporting.