|
Home / Business / Management
Business Valuation Methods
By:Finance Master
Many types of business valuation methods are appropriate when estimating or defining a business value for certain kinds of business evaluations and appraisals. The reason for the evaluation determines which measure will be used. For example, if the purpose is to borrow money, asset values will be key because lenders will be interested in collateral. If the value is based on the selling price of the business, then what the business owns, what it earns, and what makes it unique will be important. The following is a list of many different types of business valuations that can be performed.
* Insurable value
* Book value
* Liquidation value
* Fair market / stock market value
* Replacement value
* Reproduction value
* Asset value
* Discounted future earnings value
* Capitalized earnings value
* Goodwill value
* Going concern value
* Cost savings value
* Expected return value
* Conditional value
* Market data value
This article discusses six of the more popular business valuation methods: 1) Value based on assets, 2) Value based on cash flow or net income, 3) Value based on the integrated method, 4) Value based on net present value of future earnings, 5) Value based on the market data approach, and 6) Value based on the replacement cost approach.
1. Value Based on Assets
Uses: Used most often as a minimum value because a business should be worth at least the value of its assets. Exceptions might occur when a company is losing money.
Steps: Determine the market value of the assets being sold. If business is being sold, deduct the value of any liabilities being assumed by the buyer.
2. Value Based on Cash Flow or Net Income
Uses: Used when a business has few assets, the cash flow being the important thing considered here. The value is based on the return on investment the cash flow represents.
Steps: Adjust the income statement to reflect the true expenses of the business (for example, subtract personal items being paid for by the business). Calculate the appropriate, adjusted type of income to be capitalized: cash flow, net income before or after taxes, etc.. Decide, based on risk and yields of other, "comparable" investments, the desired rate of return or the capitalization (cap) rate. Divide the income to be capitalized (example, cash flow) by the cap rate.
3. Value Based on the Integrated Method
Uses: Used when a company has both assets and cash flow. This method accounts for the value of the assets and then capitalizes the cash flow, but only after reducing the cash flow by the cost of carrying the assets.
Steps: Determine the market value of the assets. Multiply the value of the assets by the interest rate the company pays to borrow money to get the cost of carrying the assets. Adjust the income statement to reflect the true expenses of the business. Calculate the appropriate, adjusted type of income to be capitalized: cash flow, net income before or after taxes, etc.. Subtract the cost of carrying the assets to get the excess earnings. Decide, based on risk and yields of other, "comparable" investments, the desired rate of return (the cap rate). Divide the excess earnings by the cap rate to get the value of the excess earnings. Add the value of the excess earnings to the value of the assets and subtract the value of any liabilities being assumed by the buyer if business is being purchased.
4. Value Based on Net Present Value of Future Earnings
Uses: Used as a method to sell the value of a projected future stream of earnings at a discount. Used mainly with larger, well-documented companies for which the future is somewhat more predictable.
Steps: Adjust the profit-and-loss statement to reflect the true expenses of the business. Calculate the adjusted actual cash flow. Based on supportable plans, project financial statements for 5 years. Forecasting techniques could use moving averages, trending, percentage increases/decreases, or multiple regression. External factors such as industry outlook, technological developments, and government regulation should be considered. Determine cumulative cash flow for the 5 years and discount it to establish the net present value. Each year may be discounted separately to give a more precise value.
5. Value Based on the Market Data Approach
Uses: Value of the business (or other property) is estimated from information on prices actually paid for other, similar, businesses or properties. This the most direct valuation approach and it is easily understood by laymen. However, it requires a reasonably active market, the necessity of making adjustment to actual selling prices in an attempt to compensate for differences and it is generally not applicable to estimating values of intangibles.
Steps: Identify other businesses or properties generally similar to the one being appraised, that have actually been sold. Determine the selling price, then compare each comparable sale with the property/business being appraised, and adjust actual selling price of each comparable property/business to compensate for the significant differences between it and the subject property/business. Use these adjusted selling prices of the comparable properties/businesses as a basis for estimating, by inference, the market value of the subject property/business.
6. Value Based on the Replacement Cost Approach
Uses: Value of the business is determined from the estimated cost of replacing (duplicating) the business asset by asset and liability by liability. Very accurate in valuing tangible assets and reflects actual economic value. Used with asset-heavy businesses such as hotels/motels and natural resources (mining) businesses. Does not take into account the earning power of the business which contributes to total value.
Steps: List all assets to be included in the valuation of the business. Omit any surplus or idle assets that do not contribute to the economic performance of the business. Also, list liabilities, if applicable to appraisal. Estimate the current cost to replace each asset with functionally equivalent substitute; also estimate current value of each liability to be included. Add the estimated costs to replace the individual assets, thus determining the total estimated cost of replacing all assets in aggregate. Subtract estimated current values of liabilities, if applicable. Add the values (liquidation value, wholesale market value, etc.) of any non-contributing assets omitted in the first step.
Reconciling the Value Estimates & Determining the Final Estimate of Value
* Compare the value of estimates resulting from the use of different approaches
* Rank each by the relative degree of confidence
* Use judgment
* Test the final value estimate
* Round the final value
* No useful purpose is served by taking an average
Digg
del.icio.us
Blink
Stumble
Spurl
Reddit
Netscape
Furl
Article keywords: business value, business valuation, business evaluation, business appraisal, replacement cost, cash flow, market value, net present value of future earnings, net income
Article Source: http://www.articles2k.com
Finance Master is the Editor of TotalFin.com and SeekFin.com.
For financing and investing advice and tools via articles, examples, templates, spreadsheets, and calculators, visit these sites:
TotalFin.com
and
SeekFin.com
where you will learn about auto loans, business lending, equity capital fund raising, business planning, commercial real estate financing, home mortgages, and stock investing.
|
|
| Top Management Articles |
- 1). Nine Reasons Why Mentoring Matters to You By : Kevin
There are many roles we play or hats we wear in our lives. We are professionals, family members, brothers, sisters, co-workers, leaders, coaches, friends, parents, and neighbors to name just a few. While you may not wear all of the hats I listed, you can likely add several more that I left out! Many of these roles are a given – we don’t have much choice of having the role – they come with being a responsible adult.
|
- 2). Project Management - Design and Development Projects By : Michael Russell
There’s no getting away from it, design and development projects are a nightmare to manage successfully, particularly the development of software. Nonetheless, in these days of customers requiring ever increasing functionality and ever more sophisticated technology, they are sometimes necessary.
Your company almost certainly has procedures in place such as Make or Buy (do you design/build the item yourselves or do you sub-contract) and Design to Cost (you’ve estimated how much it will cost, now make sure that it doesn’t run over budget.
|
- 3). Defining Supply Chain Management By : James Hunt
Companies that deal with inventory will have to have some sort of system in place to effectively manage the supply chain that exists for any type of sales. A system of inventory needs to be as smooth running as possible so that a company is able to fulfill all its orders in a timely manner...
|
- 4). Customer Advisory Boards By : Paul Lemberg
Customer Advisory Boards are a great source of information about your market and your business. Their advice is more valuable than any management consultant's. They provide real world counsel on what you are doing right, what you are doing wrong, and most important -how to stay competitive. After all, they're the customer. They're the one's who buy your stuff.
|
- 5). 6 Ways to Maximize Learning By : Steve Kaye
Here's how to gain the most from training events.
1) Know what you want
Before the workshop, set learning goals for yourself. What do you want to learn? How can this program help you? What would make you feel that your time was well spent?
2) Ask for what you want
As the program unfolds, ask questions that guide the presentation toward the information that you need.
|
- 6). Save Face, Time, and Money on Your Next IT Project By : Leslie Whinery
How many times have you been involved in a project where a newly-released piece of software required an immediate enhancement because the right people were not “in the loop”? This is an example of how poor communication costs money and damages the reputation of an Information Technology (IT) Team.
Well-managed communication can increase the rates of success on your IT projects by improving relations between you and your customers and decreasing the odds of hasty last-minute enhancements, thus saving face, saving time, and saving money.
|
- 7). Decision Making "Pub" By : Claude Jollet
This article will help transform your decision making process into “PUB” - Pure Unadulterated Bliss!
Think I'm exaggerating? Well ... maybe just a little!:-) But, see for yourself anyway! You might be in for a pleasant surprise. The way I make decisions in complex situations has – at least – the merit of turning decision making into an effective, satisfying, even reassuring experience.
|
- 8). The CEO is 10,000 feet above the fire By : Larry Galler
How many times have you heard a business owner or manager say that they spend their workday “always sweating at putting out fires?” I hear it all the time.
Think of a raging forest fire. There are sweaty fire fighters working hard, just yards in front of the flames. There is one person in a helicopter 10,000 feet above the flames. Those on the ground and the one in the helicopter are all looking at the same fire but they have totally different views.
|
- 9). CPAs vs. Non-Certified Accountants - Clearing Up The Confusion By : John Day
I wish I had a nickel for every time someone asked me what the difference is between CPAs and non-certified accountants. Essentially, non-certified accountants can simply hang up their shingle and open their doors for business. There are no educational requirements. If they want to prepare taxes, most states require a certain number of qualified hours of study plus continuing education hours each year.
|
- 10). Many Kinds Of Banks - Many Kinds Of Accounts By : Sintilia Miecevole
Sometimes looking into opening an account or accounts in banks can be confusing. There are so many types of banks and bank accounts! Which banks are right for you to open anaccount in? Which types of accounts do you need to open? Below are some simple explanations of several types of banks and the accounts you can open. One will surely be right for you!
There are many kinds of banks:
1.
|
| New Management Articles |
|
|
|
|
|
|
|
|
|
|
|
|
- 7). Double Your Profits with Business Coaching By : Kris Koonar
Business as we all know, involves risk. Since starting up your own business means starting a new chapter of your life, you may fail to recognize a few shortcomings in your business plans, as you are too engrossed and feel that things are going great.
|
- 8). Modern Business Strategies and Tactics By : Kris Koonar
Modern business strategies and tactics often concentrate on developing international brands and products, but before developing any product it is important to assess the potential worldwide demand.
|
- 9). Avoiding Poor Time Management By : ian Williamson
Around midnight students across the country become record setting authors by finishing essays, and study groups for tests in unheard of time. This unnerving process often leads to below average results. Many people wonder why this is happening, the answer is poor time management.
|
|
|
|
|
