Business Valuation

Business valuation is a process applied by qualified valuation experts to determine the fair market value of an owner’s interest in a business. Business valuation is often used to resolve disputes related to estate and gift taxation, divorce litigation,

=== Economic Conditions ===

A business valuation report generally begins with a description of national, regional and local economic conditions existing as of the valuation date, as well as the conditions of the industry in which the subject business operates. This section of the business valuation report provides a context in which the subject business can be studied and compared to other businesses.

Stock market trends, gross domestic product, employment, inflation, interest rates, and consumer spending are some of the economic indicators that are usually discussed in the first section of a business valuation report. The conditions are examined as of the valuation date, which may substantially pre-date the date of the report. Business valuation professionals are permitted to consider only facts that are known or knowable as of the valuation date. Events that were not reasonably foreseeable on the valuation date cannot affect the business valuator’s opinion of value.

A common source of economic information for the first section of the business valuation report is the Federal Reserve Board’s Beige Book, published quarterly by the Federal Reserve Bank. State governments and industry associations often publish useful statistics describing regional and industry conditions.

=== Financial Analysis ===

After reviewing economic conditions to provide context, the business valuation report examines the subject company. A history of the company is often included, as well as a description of the organization, its business lines, products and services, its management, customers, competitors, and employees, and its financial performance.

The financial statement analysis generally follows a description of the subject company. One of the first techniques that a business valuation professional applies is called “normalization” of the subject company’s financial statements. Normalizing the company’s financial statements permits the valuation expert to compare the subject company to other businesses in the same geographic area and industry, and to discover trends affecting the company over time. By comparing a company’s financial statements in different time periods, the valuation expert can view growth or decline in revenues or expenses, increases or decreases in assets or liabilities, or other financial trends within the subject company.

Valuation professionals also review the subject company’s financial ratios, such as the current ratio, quick ratio, and other liquidity ratios; collection ratios; and other measures of a company’s financial performance.

=== Income, Asset and Market Approaches ===

Three different approaches are commonly used in business valuation: the income approach, the asset-based approach, and the market approach. Within each of these approaches, there are various techniques for determining the [[fair market value]] of a business. Generally, the income approaches determine value by calculating the [[net present value]] of the benefit stream generated by the business; the asset-based approaches determine value by adding the sum of the parts of the business; and the market approaches determine value by comparing the subject company to other companies in the same industry, of the same size, and/or within the same region.

In determining which of these approaches to use, the valuation professional must exercise discretion. Each technique has advantages and drawbacks, which must be considered when applying those techniques to a particular subject company. Most treatises and court decisions encourage the valuator to consider more than one technique, which must be reconciled with each other to arrive at a value conclusion. A measure of common sense and a good grasp of mathematics is helpful. 

 

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