A Few Words
There are several valid reasons for Business Valuation or wanting to know the monetary value of a business:
- You started it from scratch — investing your own time and resources into the business — and now you want to measure how far you’ve come.
- You plan on acquiring a business, and you need to know how much it’s worth before you make an offer.
- You have a business you’ve built up over the years, and one of your retirement plans is to sell the business to fund your retirement.
- You’ve bought a business to sell it, and after stabilizing its operations, you want to see if your efforts have paid off so you can sell it.
- You’ve already sold off part of the business, and you’d like to know what the rest is worth.
SELLING PRICE AND BUSINESS WORTH
Business worth is the price the business is expected to sell for. The actual price can vary depending on who does the business appraisal and other factors. For example, if you want to purchase the business immediately because it fulfills certain lifestyle goals, you may be willing to pay more than someone who wants a revenue stream at the most affordable price.
There are three basic ways to determine the value of a business. Each has advantages and disadvantages:
1. Market Approach
2. Asset Approach
3. Income Approach
The market approach relies on indicators from the marketplace to determine the worth of the business. The economic principle of competition applies, so the business appraiser asks what similar businesses are worth and uses that knowledge to establish a price. Just like appraising a home, the small business valuation expert looks for comparable sales or valuations.
If you want to buy a business, decide what kind of business you want and then research the going rate for similar businesses in your area. If you wish to sell a business, research the marketplace to see what businesses like yours are selling for. In either case, research market data to support your asking price or offer.
The market approach determines a business’s fair market value. The fair market value refers to the price buyers are comfortable paying — and one that sellers also find acceptable. In a fair market agreement, the buyer and seller aren’t acting under compulsion and are aware of all the relevant facts.
The asset approach for valuating a business counts all the assets and liabilities to determine the value of the business. Based on the economic principle of substitution, the asset approach estimates what it would cost to create another business similar to the first to produce the same revenue. This process involves setting a standard of measurement and using that to determine asset and liability worth.
Every business has liabilities and assets, so it’s natural to look at them when trying to determine the value of the business. The difference between assets and liabilities is the value of the business. The challenge in using the asset approach is figuring out which assets and liabilities to examine in the process.
The income approach of business valuation in NYC examines the primary reason for going into business — to make a profit. This business appraisal uses the economic principle of expectation. The income approach weighs the revenue and benefits that the buyer receives against the time, money and effort that they need to invest into it.
The risk in the income approach is that it attempts to measure future profit. Since there’s no money in the bank yet, you can’t be sure when or if you’ll receive revenue from the business. Business evaluation services provide current value, not future value, so you may be buying or selling based on expected income that has to be translated to today’s marketplace.
The income approach makes this translation through discounting and capitalization. Discounting projects revenue streams over a period of years. Capitalization divides the expected revenue by the capitalization rate. For example, a business is worth three times its annual revenue if the capitalization rate is 33 percent.
Next, you estimate the value of the business at the projection period’s end. This is known as the terminal or residual business value. The discounting calculation provides you with the present value of the business.
DIFFERENT RESULTS FROM DIFFERENT VALUATIONS
It’s possible and even likely to arrive at different business appraisals with the different methods. Since your perception of risk may differ from other buyer’s or seller’s, you may arrive at a different value. You also may have different goals and plans for the business, which affects your revenue projections.
Even if you’re using the same methods as others, you can end up with different values. Determine which approach may best serve your needs with advice from the business evaluations services experts, best CPA’s.