Business Valuation

Gregory J. Cook, EA, CPA+ Accredited Tax Advisor Past President Alabama Society of Enrolled Agents Past President Alabama Association of Accountants

Do you have the highest and most accurate valuation for your business?

Most experts advise a complete valuation to account for all of the factors which impact the value of your business. These factors include:
• Reputation
• Contracts


• Management
• Advanced technology


• Trade secrets
• Skilled employees


• Computer databases
• Excess owner expenses


• Name recognition
• Competitive advantages


There are a number of instances when you may need to determine the market value of a business. Certainly, buying and selling a business is the most common reason. Estate planning, reorganization, divorce or verification of your worth for lenders or investors are other reasons.

Valuing a company is hardly a precise science and can vary depending on the type of business and the reason for coming up with a valuation. There are a wide range of factors that go into the process -- from the book value to a host of tangible and intangible elements. In general, the value of the business will rely on an analysis of the company's cash flow. In other words, it's ability to generate consistent profits will ultimately determine its worth in the marketplace.

Business valuation should be considered a starting point for buyers and sellers. It's rare that buyers and sellers come up with a similar figure, if, for no other reason, than the seller is looking for a higher price. Your goal should be to determine a ballpark figure from which the buyer and the seller can negotiate a price that they can both live with. Look carefully at the numbers, but keep in mind this caution from Bryan Goetz, president of Capital Advisors, Inc., a business appraiser: "Businesses are as unique and complex as the people who run them and are not capable of being valued by a simplistic rule of thumb."

An inaccurate view of the value of your business (whether too high or low) will adversely impact the success of your sales efforts.

BUSINESS VALUATION METHODS

The most common valuation methods used by accountants are:

Book Value: The accounting net worth of a business—total assets minus total liabilities. Assets are valued at their adjusted cost basis minus depreciation. The balance sheet attached to a partnership or corporation tax return is based on book value. The book value does not take into consideration certain unrecorded assets and liabilities such as the current value of goodwill, customer lists, or lease obligations.

Tangible Book Value: Book value minus intangible assets (goodwill, covenant not to compete, etc). This method only records the assets that can be collateralized. It is most often used by financial institutions.

Adjusted Tangible Book Value: Adjusts the tangible assets up or down to their fair market values. It tells what the liquidation value of a business is most likely to be. It is sometimes used in place of book value for buy/sell agreements.

Earnings Approach Valuation Method: Rather than value the assets and liabilities of a business, this method shows how the business performs or will perform. Several ways to do this are:

Analysis of average earnings over the last several years.

Analysis of projected future cash flows.

Analysis of projected future earnings.

These valuation methods give potential investors an idea of what kind of return they can expect on their investments.

Market Approach Method: Compares a business to publicly traded firms in similar lines of business. The market price to earnings ratio of the public firm is applied to the earnings or cash flow of the business being valued to arrive at a value.

Blended Valuation Method: Combines all of the other valuation methods by assigning a percentage to each. The value under each method is multiplied by its applicable percentage rate (or weighted value). The total of all weighted values is the business value, depending on the importance placed on each method. This blended approach can overcome some of the shortcomings of the other methods by considering the strengths and weaknesses of each.