Business Valuation Guide
The process of valuing a company
You can use business valuation whenever you need to know what a business is worth. Valuation is a way to measure your business value. And this measure depends on the business’ ability to produce economic benefits for its owners. It also depends on the risk of owning the business.
Professionals often call this process business appraisal. Their toolkit includes a number of methods under the 3 key valuation approaches: asset, market and income. To measure the business worth, they follow a well-defined procedure.
From the standpoint of you, the business person, getting an accurate measure of business value depends on 6 key factors:
1. The reasons why business value needs to be determined. Also, who needs to know what the business is worth.
You may need valuation to set an asking price for a business sale, construct an offer to buy a business, get a bank loan, write a buy-sell agreement, settle a disagreement with a partner, or defend your business value in a legal dispute.
2. Circumstances surrounding the business appraisal.
It is one thing to determine the value of a business that you expect to continue operating. The business worth picture will look quite different if the business is to be closed and its assets sold.
3. Business financial and operational track record and future prospects.
It is important what the business has been able to do in the past. But business worth depends more on what the business will be able to do in the future.
4. Business ownership structure.
You may need to know the value of the entire business, a partnership share, or a controlling ownership interest.
5. Approaches and methods used to measure the business worth.
There is a number of standard business valuation methods to choose from under the asset, market and income approaches.
6. The procedure of concluding the business value.
No one business valuation method is best. Also, the results each produces may vary. A key step then is to reconcile these differences in determining what the business is worth.
How business worth is determined by pros
Business appraisal professionals are usually engaged to perform business valuation and report their conclusions. Their clients are business people or other professionals. The typical professional business appraisal process will follow these steps:
- Discuss and agree on the scope, goals and the recipients of the business appraisal.
- Outline and negotiate the fee arrangements.
- Gather the necessary information for business value analysis.
- Analyze the business and other relevant economic data. This is essential to understand the earning potential and risk associated with the business.
- Perform a reconstruction of the company’s financial statements to reveal the business earning power.
- Select and apply the appropriate business valuation methods.
- Use the results of the valuation methods to conclude what the business is worth.
- Compile and report the findings to the client.
What a business appraiser does
Note from the steps above that the business appraiser must spend considerable time and effort understanding the appraisal assignment, gathering and analyzing the business and other relevant information and reconstructing the company’s historic financial statements.
Since the appraiser is not initially familiar with the business, he or she needs time to gain an in-depth understanding of the business, its market place, and its economic prospects.
Typically, this calls for site visits, external economic data analysis and careful study of the business specifics.
Only then can the appraiser make an informed judgment as to which approaches and methods to use to measure the business value.
A word of caution: beware of promises for quick and low cost business appraisals. A professionally done business appraisal takes time. And time costs money. As the saying goes, you get what you pay for.
The appraiser will next select one or more business valuation methods under the standard valuation approaches. The appraiser typically starts with the company’s historic financial statements as a starting point.
He or she then makes the adjustments and earnings projections to reveal the business earning potential. With these adjustments in hand, the appraiser applies the selected business valuation methods.
To conclude the business value, the appraiser uses informed judgment to assign a relative weight to each result.
Finally, the appraiser compiles the findings of business value in an appraisal report which is delivered to the client.
What you as the business owner can do
You may notice that the process of professional business appraisal requires that the business owners do the following:
- Explain the need and circumstances of the business valuation to the appraiser.
- Educate the appraiser about the business financial, operational and ownership structure.
- Meet with the appraiser to discuss the valuation assignment, agree on the professional fees and time table.
- Provide the business information required by the appraiser to perform the valuation.
- Review and understand the appraisal report and its conclusions of value.
- You are well aware of the need and circumstances which call for the business valuation.
- You already possess the knowledge of the business financial and operational performance.
- You can use that knowledge to perform the financial projections and adjust the historic business financials.
- You can assess the economic prospects of the business based on your in-depth understanding of the operation and its market place.
- You can calculate the business value using the standard business valuation methods.
- You can conclude what the business is worth based on your analysis and calculation results.
Advantages of doing your own business valuation:
1. Save money.
This may be obvious – with professional appraisal fees running $5,000 – $10,000 and higher, the cost savings to you are considerable.
2. Save time.
As you can see, selecting, engaging and interfacing with a business appraiser requires that you invest a considerable amount of your own time and effort.
3. Gain the understanding of what creates business value and how it is measured.
Delegating business valuation to a professional has an important but less obvious side effect: the appraiser gains the understanding of how business value is created and measured in your business.
Doing your own business valuation gives that knowledge to you.
4. Be in a strong position of knowing what your business is worth.
The knowledge you gain from measuring your business worth yourself is a highly valuable asset. This knowledge puts you in a strong position – when negotiating with partners, lenders and investors, authorities or parties to a business sale or purchase transaction.
5. Increase your business worth.
You can use your business valuation findings as a planning tool. Since you now know what drives your business value, you can effectively plan and make value-enhancing changes in the business. The result is increased business worth.
Tools to do your business valuation
ValuAdder business valuation software comes with a complete set of business valuation tools to help you prepare for and measure your business worth:
- Market value comparisons by industry.
- An industry-standard way to measure the value of business goodwill.
- Standard income-based business valuation methods.
- Deal structuring tools to put together a business sale or purchase.
- Financial decision making tools.
- Learning and Info Center which covers the business valuation concepts, tools and techniques used in professional business appraisals.