Valuing A Business



Valuing A Business

Intro: Welcome to Valuing a Business powered by Virtual Advisor. To navigate through the workshop, click on the continue and previous buttons. To begin the workshop, click on the continue button.

Section 1: There are several pivotal times during the life of your business at which you will want to know the true or fair market value of your own company, or the value of another entity. These circumstances may include buying an existing business, selling a business, merging with another business, going public, taking on private investors or passing on a business to any heir in an estate or as a gift. When you are in one of these situations, you will want to determine exactly how much the business in question is worth. Essentially, how much can it command on the open market. The fair market value of an entity is typically defined as the amount at which the property would change hands between a buyer and a seller when neither of them is under the compulsion to buy and when they both have reasonable knowledge of relevant facts concerning the business. But what are those relevant facts and how can you go about assessing them to achieve the fair market value. We will answer these questions and more as you proceed through the workshop. For the purpose of illustration, let’s start from a blank slate and assume you are trying to value your existing business. How do you begin to know what the company is worth? Even if you know your key figures, such as sales, gross revenue and profitability, and you can estimate its growth potential, you still may have many missing blanks to fill in when it comes to knowing that business’ true value. Generally there are three methods for valuing your business. The income approach, the asset approach and the market approach. Of course, you can also hire a professional business appraiser to conduct evaluation if the deal is a complex one or if you need someone to verify your calculations. In the following sections we will discuss each of these methods in detail and provide case studies and examples to illustrate them for you. Before you proceed, you may want to gather your balance sheet, financial statements and any other documents that contain data relating to the value of your business’ income, assets and financial health. They will assist you in applying the following valuation strategies to your own business using real figures as you go along. Click on the continue button to learn about the first method, the income approach.

Section 2: The income approach to valuation is used to determine potential future income and is typically appropriate when evaluating small closely held businesses that are not asset intensive. Basically, this method is based on the premise that a business’ value is intrinsically tied to the present value of income it can generate in the future. It estimates future cash flow then discounts it using a capitalization rate which is a percentage used to convert income into present value. The key to using this approach correctly is finding the proper capitalization rate that will reflect both the riskiness associated with your business or industry and the uncertainty of its future cash flow. There are complex formulas for determining capitalization rates that are beyond the scope of this workshop. You can research the internet and trade publications for those that are appropriate for your industry and business size. For our purposes though, we will use a conservative rate of 25%. Let’s assume you own a small retail operation. We will say that the business has projected in 2005 sales of $500,000. To find the fair market value, it is then necessary to divide that figure by the capitalization rate. Therefore, the income approach would reveal the following calculations. Projected sales are $500,000, capitalization rate is 25%, so fair market value is $125,000. As the figures show, a reasonable valuation for the business would be $125,000. There is a variation of the standard income approach called the multiple of earnings approach. Click on the icon to learn more. When you are finished reading, click on the continue button to move on to the next approach.

Section 3: The next approach is the asset approach. The asset approach to valuation may be the most straightforward method because it is based directly on the value of a company’s assets less any liabilities it has incurred. It takes into consideration, not only tangible assets, meaning equipment, furniture, inventory and so on, but also intangible assets that constitute good will and provide economic returns to the company, including name, reputation, customer patronage, location and the like. It’s appropriate to use this method when the business’ profits are small in comparison to the assets used to generate them. Let’s revisit our example of a small retail shop and conduct an asset evaluation to make sure that the value arrived at using the income approach is greater than the value of the assets owned by the business. If it is not, the asset approach would be more appropriate in determining the value of this company and its profits would not justify the business’ investment in the assets it owns. As you can see in this case, since the asset value derived is lower, it would be more appropriate to follow the income approach to valuation. Click on the icon to learn about an additional value approach. When finished reading click on the continue button to move on.

Section 4: The market approach is a way to determine the value of a business by comparing the subject to similar public companies that have been recently sold. If you decide to use this approach, you can start by consulting the following sources for comparative information. As yourself the following questions when seeking potential comparative companies. When you are finished with the questions, click on the icon to learn more about this approach. When you are finished with that click on the continue button to move on.

Section 5: Now that you have become familiar with the various approaches to valuation, you can decide whether it is a task you and your team feel comfortable tackling on your own, or whether you would rather enlist the help of a professional. You can find appraisers who specialize in you geographic area and industry by doing a simple web search or speaking to your current financial or legal advisors for recommendations. Depending on the particulars of your situation, you may also wish to seek out an appraiser who specializes in valuing specific assets including inventory, equipment, real estate and buildings. You can expect to pay appraisers between $100-$200 dollar per hour on average for their services. If you decide to go this route be sure to get the appraiser’s findings in writing in case you need to provide proof of how he or she arrived at his or her calculations. Good Luck.

Section 6: For additional information on this topic click on the resource and worksheet buttons at the top of the page. To talk with peers or an expert on this subject, click on the Discuss and Ask the Expert sections at the top of the page. Good Luck.

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