Understanding a business valuation

The ultimate true value of any business is the price accepted by the buyer where both the buyer and the seller willingly enter into the transaction without being compelled to do so. However, at the time of sale how do you know the value to commence negotiations with? Get a business valuation.

What’s involved in a business valuation? One of the first stages of a valuation job is gathering information, usually in the form of documents including historical financial statements, tax returns, customer lists, client lists, supplier lists, asset register, unresolved legal actions, etc; anything that verifies income, expenditure and quality of the business historically. This then provides some insight concerning the businesses earning capacity in the future.

A basic premise of any valuation is that the buyer and seller are acting rationally. In this context, theoretically, nothing will be paid for the business today, that would be in excess to what it is expected to produce in profits and cash in the future. In the very simplest of terms, a business should be worth its future cash flows which are reinstated into present day dollar terms. This is a mathematical calculation however the valuation process considers a number of other considerations. For example, a business is expected to remain a “going concern”, which as we all know, is far from certain. This uncertainty is factored into the valuation. Professional judgement (or the “art” element) plays a role in arriving at the appropriate risk factors and future potential benefits to incorporate into the valuation.

A full scope valuation is done in conjunction with an analysis of the wider economy, technology, social and political influences and the industry to which the business belongs, which is a vital step in assessing the future of the business. For example, think of the value of a postal business 20 years ago in Australia. At the time, it was a monopoly making enormous profits and cash and that would lead to an exceedingly high valuation. However, good professional expertise and judgement would factor in the impact of email on that business.

While a great deal of sound financial mathematics is used in the valuation process there is an element of subjectivity, and that is where experience and professional judgment become vital. In the end, a business valuation is a very serious piece of work that contains significant financial analysis and well thought out conclusions which will provide practical guidance for the business sale or purchase negotiations to commence.

 

Written by Chieftains an accounting firm that performs business valuations designed for use in anumber of circumstances such as purchase or sale of a business, management buy-outs, divorcesettlements, commercial disputes, insolvency or determining value for business succession planning.

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