Understanding Business Valuation

There are many reasons why a business owner would want to be able to set a determined value for the business. This is achieved through a process called business valuation. The individual procedures and prescribed processes that go into a business valuation are complex, but the following information can help you gain a general idea of what it involves.

If you’re a small business owner, you don’t have to worry about conducting a business valuation, but it’s beneficial and reassuring to understand the basic outline of the process in the event that you would consider selling your business in the future or purchasing another business.

business-valuation-1 The goal of a business valuation is to arrive at an estimate of the economic value of a business or of just one owner’s individual interest in his or her business.

“Business valuation can be used to determine the fair value of a business for a variety of reasons, including sale value, establishing partner ownership and divorce proceedings,” states Investopedia.com. “Often times, owners will turn to professional business valuators for an objective estimate of the business value.”

This is a very involved procedure, and there are many tactics to decide between. Even when an initial valuation method is chosen, the options continue to branch in seemingly endless combinations.

Regardless of the methods that are chosen, there are certain aspects of value that must be established. This includes fair value, which is a determination of the value that an investor could receive through cost synergies. There is also fair market value, which is the value that could be gained from an asset sold on the open marketplace.

Even before these basic values can be determined, the very nature of the business’s operations must be established. There are two main possibilities at this step. The first is to assume that the business in question will continue its operations for the foreseeable future, with no plans on ceasing. In this case, the basic premise is referred to as “going-concern.”

It makes sense that if a business was on the brink of a big change, the process for putting a value on it would be different. Consider purchasing a coffee shop and continuing to run it as a coffee shop, with the same products and customers, versus turning it into a restaurant or closing it down to sell the assets. In each of these instances, different values would be realized by the purchaser.

business-valuation-2Fittingly, the counterpart to a “going-concern” premise is a liquidation premise. In a liquidation premise, the goal is to determine how much a company would be worth if it went out of business and the assets were sold.

There are several approaches that are commonly used to go about a business valuation engagement once the basic premise is determined. The three main approaches are the Market Approach, the Asset Approach and the Income Approach. Even within one of these three approaches, there are a variety of methods to choose from, such that two business valuations using the same primary approach may not conduct the process in the same way.

“For example, within the Income Approach, a business valuation professional can choose to use a capitalized cash flow method, the discounted cash flow method or the capitalized excess earnings method,” states Jessica Ballard from Sageworks on Entrepreneur.com. “It is up to the appraiser’s “professional judgment” as to which of these methods to use within each approach, and how much weight to apply to each.”

If your company is undergoing a business valuation, you can expect to have important documents collected including vender lists, customer lists, tax returns, depreciation schedules and past financial statements. Furthermore, any documents relevant to the business’s structure, such as if it’s a corporation, will be examined.

With this information, the entity conducting the analysis will make complicated calculations about the business’s value based on the current economy. This will also depend on whether the business is publicly traded or not.

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