What is your business worth and why does it matter?
Valuations can be used for a variety of reasons including: business sale and purchase price analysis, establishing value for estate and gift taxation, obtaining financing, succession planning, and matters tied to divorce and ownership disputes. In addition, one of the best reasons to obtain a business valuation is to use it as a management tool.
A business valuation can provide management with the information necessary to identify a business’ strengths, its weaknesses and identify what is driving value.
There are three different approaches a business appraiser can use to determine business value.
Asset Approach
The asset approach provides us with the “floor” value of a business. It is the net result after arriving at the fair market value of business tangible and intangible assets and the business liabilities. This approach sounds simple but deceptively so. Many times, some of the most important business assets are not included on the balance sheet of your company such as goodwill and internally developed products. The fair market value of all business assets and liabilities must be accounted for under this business valuation approach.
Market Approach
The market approach values a business by researching recent company sale transactions, and applying the ratios (annual revenue to sales price, gross profit to sales price, net income to sales price, etc.) from these transactions to your business in order to arrive at the business value. Value is based upon the recent prices buyers have been willing to pay and sellers willing to accept for businesses that are similar to yours based on size (in terms of revenue, total assets, etc.), industry and location.
Income Approach
An income approach arrives at business value based on the cash flow producing capacity of your company and risk. One of two methods are often employed. The capitalization of cash flows method divides the business’s historical cash flow from a given time period by a capitalization rate (expected return on investment) in order to arrive at business value. The discounted cash flows method takes the projected business income over a future period of time divided by a discount rate (expected return on investment) in order to arrive at business value. The difference between the capitalization rate applied to historical cash flow and the discount rate applied to projected cash flow is anticipated “growth”.
Conclusion
Business valuation is complicated. Hurdles often arise and there are many factors that enter the process. Judgement is involved, decisions on which approach and method is most appropriate must be made, assumptions come into play and are documented, there are tax matters to be taken into consideration, and many other factors specific to the purpose for valuing the company that must be taken into account.
The business valuation process is often referred to as more “art” than “science”. Unfortunately, it is not a simple matter of “calculating the number”. The benefits of the process are having a better understanding how much your business is worth and a better understanding of what drivers most greatly affect the value of your business. A business valuation analysist can help you with this process. Please do not hesitate to give the valuation experts at Wegner CPAs a call with your questions.
