Businesses, both small and large, at some point should consider having a business valuation performed to provide a snapshot of a company’s financial well-being. A business valuation is useful in estimating the economic value of an owner’s interest in a business. The actual value of a business between market participants is simplified by estimating the amount a buyer is willing to pay and seller is willing to accept.
Business valuations can be used for a variety purposes, such as buy-sell agreements, purchase price allocation, financing, estate and gift taxation, partners’ ownership interests, financial and tax reporting, and litigation support.
Valuing any company is not an exact science and the methodology can vary depending upon the type of business, the size of the business, and intended use of the appraisal. What can complicate the scenario is that there are several valuation methods that can be employed, including asset-based valuation, income capitalization, and market valuation (comparable sales) method.
Asset Valuation Approach is most useful for asset intensive businesses, such as manufacturing and retail businesses. These types of businesses tend to have significant fixed assets, equipment, or inventory. The value of the business is determined by the total value of the company’s tangible and intangible assets. Drawbacks include failure to value the goodwill of a business and also neglecting the value of the company’s future earnings potential.
Income Capitalization Approach is typically used for service type companies, which are not typically asset intensive. It involves converting future anticipated economic benefit (e.g., cash flow) into present value by dividing a company’s annual historic earnings by a capitalization rate, which incorporates risk and future annual growth. Income could be represented as pre-tax profit, after-tax profit, or earnings before interest, taxes, depreciation, and amortization (EBITDA). Methodology includes utilizing capitalized cash flow (CCF), discounted cash flow (DCF), or excess cash flow (ECF). It can be difficult to estimate future performance for companies without a sufficient earnings history.
Market Valuation (Comparable Sales) Approach utilizes industry specific multipliers and actual transactional data to determine a company’s value. These multipliers, based on gross sales, provide a more simple and tangible way by which to compare different businesses in different industries and locations. A limit to this approach is finding a precise match to the business being appraised.
Liberty Valuation Group can help you manage the business valuation process by working with you to determine the purpose and intended use of the appraisal. Our appraisers carry professional designations and accreditations and will counsel you on the appropriate scope of work and methodology.