Business Valuation Q&A
Many business owners will go through the business valuation process maybe one or two times during their career. For most, a valuation is needed during the succession planning process, when consideration is being given to purchasing a company, or for planning purposes. As a result, the valuation process is unfamiliar. There are many unknowns, including what to expect, what’s needed to start a valuation, what’s included in a valuation report, and different business valuation methods available. To help clients, prospects, and others become more familiar with business valuations, Selden Fox has compiled the following questions and answers for reference.
What type of reports do you issue?
We provide three different types of reports depending on the level of detail desired.
- Detailed Valuation Report: This is a formal presentation, presenting a conclusion of value. This type of report follows reporting standards to ensure consistency and quality of valuation reports. The final report is based on a comprehensive review and analysis of the business, its industry, and all other relevant factors. A detailed valuation report are generally only needed for litigation cases and Employee Stock Ownership Plan (ESOP) reports.
- Summary Valuation Report: A summary report sets forth a conclusion of value through an abridged version of the information that would be provided in a detailed report. A summary valuation does not contain the same level of detail as a detailed valuation. In this report, the valuation analyst is still required to preform materially the same investigation and analysis that is required for a detailed valuation report, however it is intended by the parties to reduce the normal appraisal burden of writing a detailed valuation report. This report is often a more cost-effective approach to business valuation when a detailed valuation report is not required. This report is generally used for estate and gift tax purposes, a merger or acquisition, and SBA or conventional financing purposes.
- Calculation Report: A calculation report presents a calculation of value rather than a conclusion of value. In a calculation report, the valuation analyst and the client are using agreed upon procedures, which therefore limits the amount of investigation and due diligence. A calculation can be a very useful tool for business owners or professionals in planning stages who would like an idea or estimate of what their business is worth. This report is generally used for estate planning and business planning.
What is included in a business valuation report?
A valuation looks at three different analysis to compute the value: an income analysis, an analysis of the assets/liabilities of the business, and a market analysis of what similar companies, both private and publicly traded have sold for in the past.
A valuation also includes other reporting requirements that must be adhered to by the valuation analyst. These reporting requirements include items such as an analysis of how the economy and industry are performing and a ratio analysis to see how the company is performing against similar companies. All of these factors contribute to the final valuation price.
The business valuation process not only entails careful analysis of the financial statements of a business enterprise but also requires a thorough understanding of the business operations. This includes looking at the following factors to consider what affect the risk of ownership in a particular enterprise and the riskiness of a business directly impacts the value:
- What are a company’s strengths, weaknesses and vulnerabilities?
- What is the competitive environment?
- How concentrated is the business’ customers and suppliers?
- What are the overall expectations of the marketplace?
- How does the future look for the economy and the industry?
- How much is the company growing?
The business valuation process is incorporating the financials (past, present, and future) as well as the business operations to calculate the value of a company.
Are there different approaches to doing a valuation?
There are generally three different approaches to value a business: the asset approach, the income approach, and the market approach.
The asset approach generally applies to holding companies and real estate companies. The simplistic calculation is assets less liabilities equals the value of the company, however it is more complex than that as assets need to be adjusted to the fair market value and other assets that may not be on a GAAP financial statement need to be considered, such as intangible assets.
The income approach is used when the earnings capacity are a factor of the company. The capitalization of earnings and the cash flows method are the two most common methods when using the income approach. The most critical component in valuing a business is its ability to generate future earnings/cash flows, therefore this method is used in valuing a profitable business where the investor’s intent is to provide for a return on investment over and above a reasonable amount of compensation.
The idea behind the market approach is that the value of a business can be determined by reference to reasonably comparable guideline companies for which transaction values are known. The values may be known because these companies are publicly traded or because they were recently sold and the terms of the transaction were disclosed. Since the objective of an appraisal assignment is usually to arrive at an opinion of market value, it is logical to examine values determined in the marketplace.
What items are needed to perform a business valuation?
The following items are needed to perform an accurate analysis:
- Interim financial statements
- Financial statements for the past five years
- Tax returns for the past five years
The valuation analyst will also need to have discussions with ownership regarding the company and its operations, and may ask about other important information such as customer and vendor concentration, organizational charts, payroll data, and other pertinent information that impact the value of the business.
What types of companies do you value?
We specialize in valuing small to mid-size privately held businesses in a variety of industries, including manufacturing, retailing, distribution, advertising, and real estate. We also value professional practitioners such as attorneys and dentists.
The business valuation process is often more complex than most realize. There are several variables which must be examined depending on the purpose of the valuation and company being examined. If you have questions about business valuations or are interested in having one conducted, Selden Fox can help. For additional information call us at 630.954.1400 or click here to contact us.