Much like a real estate appraisal, the business valuation process must take into consideration three fundamental valuation approaches.
First, the adjusted book value of a business reflects the business’ accounting value, adjusting assets to market value. It reflects the book value or net worth of the business based upon the market value or replacement value of the business’ assets. It does not reflect the value of goodwill or any other intangible.
Next, the earnings capacity of a business is reflected in its historic earnings or its forecasted future earnings. An earnings capacity value can be derived by capitalizing expected future earnings at the assumed return on investment or capitalization rate. An earnings capacity value does reflect goodwill and other intangible values.
A third valuation approach considers recent sales of comparable businesses. In this case, a comparable business is one which is not merely a business in the same industry. It is a comparable business in size, capitalization, geographic region, competitive environment, etc. As one might imagine, a recent sale of a comparable business is not easy to find.
The fair market value of a business should reflect its highest and best use value; therefore, the business valuation specialist must take into consideration all three approaches.
The valuation process is not as simple as this brief overview suggests. A substantial amount of time and effort is required to analyze historic financial statements, reported earnings, the age and condition of assets owned, etc. For this reason, business valuations are not inexpensive.
Often, when we are requested to perform a business valuation, we conclude that a formal valuation and a long form report are not necessary. In many cases, an estimate of value and a letter report or a verbal report will satisfy our client’s need and purpose.
Business valuations are often required in connection with estate or gift transfers of business interests, dispute resolution, particularly disputes that might lead to litigation. Like every other area of our practice, we believe the professional/client relationship is a partnership. As valuation specialists valuing your business we must have a thorough understanding of your business, your industry, its history and its future. Your input is invaluable, it’s critical. We work with our clients through each step of the process and arrive at a conclusion of value together.
Thomas A. Gaitens is a Certified Valuation Analyst, he a member of the National Association of Certified Valuation Analysts and he served on the Association’s original Advisory Board. He is also Accredited in Business Valuation (ABV) by the American Institute of Certified Public Accountants.