Business Valuation Definition
Business valuation is the process of determining the economic value of a business or company. It assesses a variety of factors to determine the fair market value in a sale, but there is no one way to verify the worth of a company. Business valuation can depend on the values of the assessor, tangible and intangible assets, and varying economic conditions. Business valuation provides an expected price of sale; however, the real price of sale can very.
Traditional approaches to business valuation employ financial statements, cash flow models, and comparisons to competitive companies within a similar field or industry.
Business Valuation Methods
Income Approach: determines business value based on income. This type of valuation focuses on net cash flow, discretionary cash flow, and capitalization of earnings.
Asset Approach: determines business value based on assets. This type of valuation focuses on asset accumulation (assets minus liabilities) and capitalized excess earnings.
Market Approach: determines business value in relation to similar companies. This type of valuation focuses on the comparative transaction method and appraises competitive sales of comparable businesses to estimate economic performance looking at revenue or profits primarily.
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Business Valuation Purposes
Although the primary purpose of business valuation is preparing a company for sale, there are many purposes. The following are a few examples:
Shareholder Disputes: sometimes a breakup of the company is in the shareholder’s best interests. This could also include transfers of shares from shareholders who are withdrawing.
Estate and Gift: a valuation would need to be done prior to estate planning or a gifting of interests or after the death of an owner. This is also required by the IRS for Charitable donations.
Divorce: when a divorce occurs, a division of assets and business interests is needed.
Mergers, Acquisitions, and Sales: valuation is necessary to negotiate a merger, acquisition, or sale, so the interested parties can obtain the best fair market price.
Buy-Sell Agreements: this typically involves a transfer of equity between partners or shareholders.
Financing: a business appraisal is required before obtaining a loan, so the banks can validate their investment.