What does business valuation mean?
Business valuation is the process of determining the overall economic value of your business.
Why determine the worth or value of your business?
Getting a valuation is often preferred (or even required) to determine the fair market value of a business for reasons including determining the sale value (to provide a good basis for negotiations), identifying each partner/co-owner’s ownership %s, applying certain tax rules, and even for personal matters such as divorce proceedings. Such valuations can also help uncover hidden financial issues unbeknownst to management or the sole-owner.
How is your small business worth determined?
There are two broadly-accepted methods available, and choosing the most applicable one depends on the nature of your company, as well as the types of transactions it enters into. The process requires more than one source of input, and typically requires a careful study of the company’s financial information, sales trends, customer base, supplier relationships, and much more.
Earnings-based methods
These methods are commonly used for businesses that generate reasonable profits and whose value is greater than that of their net assets alone. Past results are reviewed, and future cash flow or earnings are forecasted based on reasonable assumptions.
Check out our related articles on Why are Balance Sheets and Profit & Loss (Income) Statements so important? and Budgeting vs. Forecasting: What's the difference and why do they matter? Also check out how Arria CPA works with our clients to help with Forecasting!
Capitalized cash flow: Used when cash flow is projected to remain stable in future years.
Discounted cash flow: Used when cash flow is expected to fluctuate substantially in future years, such as when a company has recently started up, or is growing rapidly.
Market-based methods: These approaches apply a “valuation multiple”, which may be based on EBITDA (earnings before interest, taxes, depreciation and amortization), revenue or other metrics. The specific figure used and type of ratio vary greatly depending on many factors, including:
sales trends
past and forecasted earnings and cash flow stability
industry and location
market conditions
size and maturity of the company
customer and supplier diversification
goodwill and intellectual property
dependence on owners and key employees
workforce engagement
multiples used by comparable businesses
Asset-based methods
These methods are typically used for businesses whose value is asset-related rather than operations-related, such as those in the real estate sector. They may also be used to value underperforming businesses that are not generating a sufficient return on their capital assets, or are expected to wind down and be liquidated. In such cases, an asset specific appraiser, such as real estate or equipment appraiser, often provides additional input.
Adjusted book value method: Liabilities are deducted from the combined fair market value of the company’s assets.
Liquidation value method: Liabilities are subtracted from the amount that the company’s assets could potentially sell for in a liquidation sale, net of liquidation expenses.
What information is usually required for review?
Information typically reviewed includes the following, but will vary depending on why you're getting your business valued:
financial statements for the past three to five years
the prior year’s tax return
business location, square footage and ownership or rental status of facilities
a list of discretionary and non-recurring or one-time expenses
breakdown of management compensation
number of employees
patents, bylaws, and shareholder agreements
a sales breakdown by customer for the past three to five years (in order to determine customer concentration, which can affect value)
information on supplier concentration
Hire a specialist to get it right!
The business valuation exercise is best performed by a qualified professional business valuator, and because the value of your business can be used to draft legal agreements, or divide ownership interests, getting a report from an independent valuator is key.
An independent valuator would assess the company’s stand-alone fair market value to a non-related party. This means the company’s value without any potential synergies, goodwill, or strategic considerations that any potential buyer might see in your business. As a result, in situations where the business is being sold, the actual negotiated purchase price may differ from the value determined by a valuator due to various factors, such as the buyer’s strategic interests or expected synergies, the owner’s eagerness to sell, items uncovered during the due diligence process, available financing and business credit score, and the company’s capacity to smoothly transition to new ownership.
Schedule a meeting
At Arria CPA, we provide our clients with all the tools necessary to prepare their business for a complete business valuation, and can also help interpret the results of a valuation for relevance to their business. Contact us for a free, no-obligation consultation to learn more about how we can become strategic partners in using your business’ valuation to your advantage.
Disclaimer: Please note that this is only a brief summary and is based on current accounting regulations and tax law interpretations. Accounting regulations and tax laws are subject to continual review and change, so should the facts provided to us be inaccurate or incomplete, or should the law or its interpretation change, our summary may be inappropriate for your uses. This article is written for educational purposes only, and as such, we recommend you consult a professional before making an accounting or tax decision. If you have any concerns, or would like further consultation regarding this matter, please contact us.
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