Much like a real estate appraisal, a business valuation has the goal of concluding upon a fair market value of what the business is worth should it be sold to another on the open market. In order to properly analyze a business and make a decision about its worth, the appraiser must undergo a period of comprehensive research to collect data relevant to the company, its business, its performance, and its market. In fact, the research collected during this preliminary period is similar to the type of information required when creating a business plan.
Frazier Capital Valuation’s trained staff goes through the following procedure in order to collect the amount of comprehensive data they need to conduct a business valuation:
- Learning the company history. Bylaws and agreements between owners can shape the valuation process. Interviewing the owners might give a better idea as to what type of partnership exists, as well as providing information about any particular problems that the business has encountered, as well as information about discrepancies between owners.
- Inquiring about other subjective issues that may affect the present or future value. These issues include details of past and pending lawsuits, workers compensation issues, copyrights and patents, deeds, leases, pricing strategies and more. This information provides the appraiser with a good idea of how the company is functioning internally.
- Collect financial statements from the company. Balance sheet and income statements should go back at least three years, but preferably five years of financial statements should be included. Bank statements and checkbooks should also be reviewed as these can give the appraiser good insight to the patterns of the owners in operations.
- Collect information concerning competition. The effects that competition has on a business greatly affect its value. Interviewing competitors will help the appraiser get a better understanding of market conditions as well as differences in products and services offered between similar firms.
- Compile lists and find estimated values on the machinery, equipment, and inventory of the business. These things can affect the value of a business.
A business valuation is much more complex than an appraisal of commercial real estate. Because of the wide variety of industries and companies, as well as the large amount of accounting methods practiced by different companies, there exists several different methods and approaches to valuing a closely held business.
Each industry generally has its own rule of thumb; a quick way to gauge the validity of a concluded value on a business within that industry. However, it is important that users of “Rules of Thumb” are aware that this is by no means a way of gauging the definite fair market value of any business. Companies vary too much for any rule of thumb to be applied universally. For more on Rules of Thumb, click here. A rule of thumb may look like this: “30% – 40% of annual sales”, meaning that the sale price of the business should fall roughly between that range. However, these rules are dangerous to use.
However, four things remain relatively standard despite what industry the business is in. These four steps are:
- Forecasting the company’s cash flow for a specified amount of future years
- Estimating the cost of capital to be included in the valuation analysis
- Determining the continuing value of a business beyond the date of the appraisal
- Analyzing and interpreting the results of all calculations and assumptions that are made during the analysis.
For many companies, historical earnings data is a crucial financial variable that is used to help determine the future cash flows of a certain company. In order to make accurate analyses of this data however, the appraiser needs to have access to the company’s accounting records and methods. Without knowledge of the methods, the analysis of financial statements is worthless.
Below are a couple useful tables for determining your valuation needs.
Frazier Capital Valuation conducts our analyses using these methods to make sure that your business is accurately valued. Since each business is unique, we choose the method that is best catered to capture the true value of the subject business. Click here for more information about conducting a business appraisal with Frazier Capital Valuation.