Business valuations have many uses

Many business owners work day in and day out to build value in their companies, but few know the actual value of their enterprise.

Knowing the true value of your business is important for a number of reasons. Obviously, you need to know the value of any business you are considering buying or selling, but valuations are also needed to borrow money, take on a partner, develop or update an estate plan or gift shares of the company.

Some may think the value is based on the company’s balance sheet. Others may base the value on the cash flow. The true value of a business is actually a combination of these factors and more. Business valuations can also be based on insurable value, cost of replacement, capitalized earnings, future earnings, market data and the intangible but important goodwill value.

Generally, the methods depend on the type of business and why you’re measuring it and will fall under an asset, market or income approach. A manufacturing business, for example, may put more emphasis on the balance sheet and value of the fixed assets. A service business without a lot of fixed assets, on the other hand, might focus on cash flow, earnings and good will.

The purpose for the valuation is another important factor in determining the method. A healthy business looking for new ownership may use a very different method than a struggling one looking to liquidate or a small business owner planning to gift shares of the business to family members.

Because of all the variables, business valuations can be complicated, so the first step is finding expert help to guide you in the process. An accountant with particular experience in valuation in your industry or a valuation firm can help you determine the appropriate standard and method for evaluating the subject business.

Valuation firms generally go across industries. They find similar businesses around the country and use factors such as stock or purchase price to arrive at a fair market value. The best indicator of fair market value is what an unrelated third party would pay for the business.

Business valuations can be expensive, so it’s wise to get a couple of quotes. Prices can vary widely and will depend on the type of business, gross receipts and the purpose of the valuation.

Keep in mind, if you are evaluating a business for lending purposes, your bank will generally do its own valuation using its own tools. Although their conclusion may differ from that of an accountant or valuation firm, the bank would still use its own method when determining the amount it is willing to loan a business.

In order to perform a proper valuation, the experts will need financial statements for the last three to five years, a list of assets and depreciation schedule, organizational and operational books and records, and details of any existing employment or client contracts. It also helps to have vendor and supplier lists, insurance contracts, information about any government orders or environmental issues, land surveys and business plans and a list of licenses needed to operate the business.

Appraisers typically combine that information with external valuation processes and use a few different methods to arrive at a value. Rather than averaging the findings from the different methods, they rank them according to their relative importance in the business type and industry and arrive at a final value estimate. Most then will test the final value estimate for accuracy.

Without a valuation, it’s not uncommon for business owners to over- or under-value their companies, simply because they may not be aware of all the variables or current market prices. But if you’re looking to conduct any transaction where you need to know the actual value of your enterprise, an accurate valuation is the only way for all parties to proceed fairly and with confidence.