A business valuation is a thorough, comprehensive independent analysis of a business or business interest to determine its value.
In performing a business valuation, there are numerous steps, procedures, and analysis that must be performed to determine the value and then standards that must be followed in preparing the valuation report. These standards and requirements are set forth by the American Institute of Certified Public Accountants, the National Association of Certified Valuators and Analyst, and other organizations.
The general steps, procedures and standards used in a business valuation are described briefly below.
Standards of Value
The analyst must have an understanding of the purpose of the business transaction, so the appropriate standard of value will be used. If the valuation is in connection with gift or estate planning, the Internal Revenue Service requires fair market value be used as the Standard of Value. If a business is purchasing a competitor, then strategic or investment value may be the most appropriate method to use.
Fair value, which is different from fair market value is often required in litigation such as disputes between owners, or divorce cases.
The orderly liquidation or forced liquidation standard of value would be used in cases where a company was out of business, or is going out of business.
Premise of Value
The going concern premise assumes the business will continue to operate into the future. The liquidation premise assumes the business is closed or will close soon.
Financial statements and/or income tax returns are analyzed, generally for the last 5 years. Financial ratios are computed and compared to industries in the same SIC or NAICS Codes. Financial transactions involving comparable sized companies in comparable industries are also reviewed.
Analyses of national economic conditions are reviewed as well as the industry in which the subject operates. Last, but not least, the individual company is reviewed by means of interviews with key personnel and usually a site visit and inspection.
Once the analysis is complete, calculations using the various valuation approaches are made and then the most appropriate method or weighting of these approaches is chosen.
Business valuation theory uses three basic approaches to value.
- Asset Based Approach: A general way of determining a value indication of a business’s assets and/or equity using one or more methods based directly on the value of the assets of the business less liabilities.
- Income Approach: A general way of determining a value indication of a business’s assets and/or equity using one or more methods wherein a value is determined by converting anticipated benefits.
- Market Approach: A general way of determining a value indication of a business’s assets and/or equity using one or more methods that compares the subject to similar investments that have been sold.
The various methods of valuation that appraisers use in practice are typically considered as subdivisions of these broad approaches. Valuation methods under the Market and Income approaches generally contain common characteristics such as measures of benefit streams, discount rates and/or capitalization rates and multiples.
Valuation report and Opinion of Value
The valuation goes through the steps, analyses and procedures used by the valuation analyst to arrive at the opinion of value expressed in the valuation report. The valuation and resulting report must also comply with applicable valuation standards from the American Institute of Certified Public Accountants (AICPA), the National Association of Certified Valuation Analyst (NACVA), or other accrediting organizations.