Several business activities could require a business valuation. Whether you are seeking new investors, merging with another company, considering selling your business, getting a divorce, or doing estate planning, you may need to determine the economic value of your business.
Business valuations can be complex. As you might imagine, many factors need to be analyzed. Moreover, various methods maybe used – each of which may affect the overall total value placed on your business.
Before starting any valuation, it’s a great idea to understand the basics of each valuation method. This knowledge can help you to determine the most appropriate method to best suit your needs. An overview of some of the top methods CPAs use to determine a business’ value include:
Market Value Method/Comparable Company Analysis
The market value method is one of the most subjective ways to value a business. It attempts to value your business by comparing it to similar companies that have recently been sold. It is challenging to complete this type of valuation if there aren’t many similar companies that have been sold or if the business is a sole proprietorship with limited public information. Since this method can be imprecise, it is often not useful when trying to attract investors. More analyzed and precise approaches may be necessary for these instances.
Asset-Based Valuation
An asset-based valuation uses the business’ total net asset value less the cost of total liabilities on the balance sheet to determine total valuation. There are two ways to approach asset-based valuation methods.
The going concern method is applicable when a business plans to continue operating after the valuation and has no plans to sell any assets immediately. In this instance, the formula accounts for the business’ total equity by calculating asset value minus total liabilities.
The liquidation value method assumes that the business will cease operations and liquidate any assets. The value is based on the net cash that would be generated from the sale of assets. Generally, this approach results in a lower value than other approaches, including the fair market value method.
Discounted Cash Flow (DCF)/Income Valuation
Discounted cash flow analysis is an approach where the business’ cash flow is projected for the future and discounted back to today at the firm’s Weighted Average Cost of Capital (WACC). It is considered less subjective than other valuation methods. It uses complex financial models and deep analysis.The DCF method is often used for companies that do not expect profits to remain consistent for one reason or another.
ROI-Based Valuation
An ROI-based business valuation assesses value based upon profit and the anticipated Return on Investment that an investor or purchaser could expect after putting money into the company. For investors, this method is helpful because their investment can be translated into a percentage stake of the company. As they look at projections, they may quickly determine the anticipated return on their investment. It helps to answer questions about how long it would take to recoup the original investment and how much additional income can be generated from the investment.
Adjusted Book Value Method
The adjusted book value method of valuation is often used when a business has low profits but holds valuable assets. This approach uses the adjusted balance sheet to determine the value of the company’s assets. The book value method is different than the liquidation value method in that it accounts for the value of an asset-based upon what information is listed on the balance sheet as well as the fair market value of the appreciated assets. The liquidation value is based upon the value of the asset, assuming it is liquidated or sold. This approach is different from the market value method, which bases its worth on the total value of outstanding shares in the market. Market value tends to be higher than book value, while liquidation value tends to be lower than book value.
Capitalization of Earnings/Multiples of Earnings Valuation
The capitalization of earnings method calculates the company’s future profitability based upon its cash flow, annual ROI, and expected value. This method works best for stable businesses with the expectation that they will remain stable in the near future.
The multiples of earnings method are similar to the capitalization of earnings method, except it determines a business’ value by its potential to earn in the future. The business’ maximum worth is assigned a multiplier to its current adjusted earnings. The multiplier is determined by the industry, economic factors, and other related data.
Business valuations can be intricate, so different methods may be selected based upon the circumstances of the company. Given the complexity of all the possible methods, it’s best to work with a professional. The expert team at Shuster & Company, P.C. can answer any questions you may have about valuing your business.
A full-service Certified Public Accounting Firm located in Denver,Shuster &Company,P.C. provides quality, personalized financial advice and guidance to individuals, businesses, and the legal community. We offer an extensive range of services, with an emphasis in forensic accounting, business valuation, and litigation support.