Business valuations and appraisals are excellent financial tools companies should be aware of. In many cases the terms are used interchangeably.There are a few similarities between these processes, but they are not quite the same.Understanding the difference between these two methods will help you know which is the best one to select should you need to gauge your company’s value.
What is the Difference Between a Business Valuation and an Appraisal?
There are two primary differences between a business valuation and an appraisal. First, an appraisal generally refers to a company’s physical assets, while a valuation tries to assign value to intangible assets. Appraisals are completed to give business owners an estimate of what the minimum value of a company may be. Appraisals will look at the value of assets including inventory, equipment, real estate, and vehicles considering direct market comparisons. Appraisals can also ensure that your physical assets match what is on your financial statements.
A business valuation is more comprehensive than an appraisal. An appraisal is part of a business valuation, but in addition to reviewing the value of tangible assets, business valuations also include intangible assets, which may include the following:
- Brand and reputation
- Patents and trademarks
- Contracts
- Accounts receivable
- Customer lists
- Key employees
A complete business valuation will include both the intangible and tangible assets to develop a formal valuation. Assigning value to these intangible elements can be far more complex than determining the value of physical assets. A formal business valuation can stand up to legal scrutiny and is often required for a variety of objectives, such as:
- Securing financing or investment
- Achieving property settlements
- Settling estate proceedings
- Going through a merger or acquisition
- Any ownership change, such as one partner leaving the business
- Attempting to determine partner ownership percentages
- One owner is going through divorce proceedings
- Attempting to add shareholders or settling a shareholder disagreement
- For tax purposes
Types of Business Valuations
Not all business valuations are the same. There are several different types of valuations that can be used to get the most accurate value of the business based on the objective for the valuation. Selecting the right method for your business valuation is often vital and should be done based on the reasons for needing the valuation and the type of company you have. The common methods include:
- Market Value Valuation Method: This method is more subjective than other business valuation methods. It determines the value of your business in comparison to similar businesses that have sold. It only works when there is sufficient data and conditions about competitors to compare.
- Asset-Based Valuation Method: This type of business valuation method considers the total number and fair market value of your business’s assets less the value of its total liabilities on your balance sheet.
- ROI-Based Valuation Method: The ROI-based valuation method looks at the value of your company based on its profits and what kind of return on investment an investor could expect after buying your business.
- Discounted Cash Flow Valuation Method: This process is also referred to as one of the income approach methods. It values a company based on its projected cash flow, adjusted to its present value. It is useful when profits are not expected to remain consistent in the future.
- Capitalization of Earnings Valuation Method: This method calculates a business’s future profitability based on its cash flow, annual ROI, and expected value of certain assets, and it works well for stable businesses.
- Multiples of Earnings Valuation Method: This approach determines a business’s value based on its potential to earn in the future. It calculates this by assigning a multiplier to current revenue. The multipliers vary according to industry, business climate, and other factors.
While these valuations are easy to describe, they are often incredibly complex processes involving extensive calculations and industry knowledge. The best way to get a reliable and accurate business valuation is by working with a knowledgeable and experienced specialist. These individuals can help you understand if you need a formal valuation, or an appraisal will suffice for your needs. They can also help you determine the best valuation method for your business. To learn more about business valuations, contact Shuster & Company.
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 emphasis in forensic accounting, business valuation, and litigation support.