What Is Business Valuation?

Posted on Sep 17 2013 - 12:28am by Bates Carter

Business Valuation

As a business owner or individual, there may be a time when you are looking to purchase, sell, go public or take on an investor in a business.  The first step to take with any of these ideas is to have the business valuated. In other words, determine the value of the business. It is not as simple as it sounds. The business valuation process can be finicky. How much the business is worth and to achieve fair market value must be done by a Certified Public Accountant to ensure both the seller, investor or purchaser is getting an honestexchange.

In the business valuation profession, the Accredited Business Valuation (ABV) credential is the highest level of recognition given by the American Institute of Certified Public Accountants (AICPA). The first step to having your business valuation completedis to confirm that your CPA is ABV Certified.

A CPA certified in ABV, must achieve the following requirements:

  • The CPA is in good standing with the state licensing board
  • The CPA must exhibit experience in business valuation
  • Acquire and maintain continuing education specific to business valuation
  • Pass a thorough exam

After you have found the appropriate CPA for the job, you should understand what it is your CPA is doing during a business valuation. There are three major ways to determine the fair market value of a business: Income, Asset and Market Approach. Within these approaches are specific techniques to valuing a business.

Income Approach

The income approach is generally used when determining the value of a small business. It allows investors to estimate the value by looking at future anticipated benefits and converting it into a single present dollar amount. Your CPA will consider things such as historical income, earning potential, future revenues and capital requirements. Capital requirements are how much is needed to invest in the building and or equipment to support future revenue growth. There are two commonly used methods under this approach: The Single Period Capitalization Method and the Multiple Period Capitalization Method.

The single-period capitalization method takes into account the cash flow of a business for a single period of time (usually the coming year) and assumes that it is illustrative of the company’s future cash flow generating capacity. The cash flow figure is divided by the capitalization rate to reach an estimate of the firm’s value. This is similar to the method used to calculate the value of commercial real estate.

The multi-period capitalization method is similar, butinstead of one period of time, it forecasts the cash flow for a projected period of time, usually 3-10 years. This method converts these values into a required rate of return. Another name for this process is the discounted cash flow (DCF) methodology. The idea is to use the projected cash flow and take away the cost of capital to arrive at a current value. This value is used to evaluate the potential for investment in the company.

Asset Approach

The asset approach, also called the cost approach, determines a company’s value by focusing on the market value of the company’s assets. This valuation approach is often considered the low end of the spectrum because nine times out of ten the going concern is the value will be higher than if the company was liquidated and all the assets were appraised. The going concern value takes into account the cash flow and the company’s ability to continue bringing in profit while if a company were liquidated, there will be no future profit.

Market Approach

The market approach bases the value of the company on the selling price of similar companies. The process includes taking a look at private and public company transactions as well as public company valuation using the current stock market data. The idea behind this is that valuations of similar companies that have been sold should show a good representation of the value of said company. One disadvantage with this approach is that it is extremely difficult to find a company that is similar.

The Next Step

When thinking about which valuation method to use, most quickly find each technique overwhelming. The best way to approach this is to consult with a CPA that is certified with an ABV. A reliable CPA has an extensive tax background and can provide more than just value estimates. They should be able to help with asset allocation advice and other tax consequences related to a sale. It’s also wise to find someone that can assist every step of the way, including the buying side of the transaction. In many cases, a CPA will advise clients about risks and opportunities inherent in the business acquisition they are considering. This includes not only a value estimate, but also, a qualitative analysis of the risk of future cash flows and growth opportunities.

Photo Credit: Flickr/Sven

About the Author
Bates Carter

BatesCarter has provided individuals and businesses with sound financial accounting advice for over 50 years. We are proud to serve a wide range of businesses including Healthcare, Not-for-Profit, Real Estate and the Construction Industry.