The distinction between valuation and evaluation as nouns is that valuation is an estimate of an object’s worth, while evaluation is an appraisal, such as an annual staff performance analysis used to justify a pay raise or promotion, or a description of a specific event. A business evaluation is a term used by management consultants to describe the process of assessing a whole business enterprise and its operational effectiveness.
The terms business valuation and a business appraisal are synonymous. In the recent past, business valuation has become the most accepted term representing placing a reasonable market value on a going concern business or the value of a planned start-up company. Let’s discuss appraising (valuing) a business, the steps to obtain a professional business valuation, and the evaluation of a company’s worth.
The True Value of a Certified Business Appraisal
You’ve probably heard the term “real estate appraisal” before whether you’re a homeowner or a business owner. A real estate appraisal is a step in the purchasing and sale process that determines the worth of a home before it is sold.
Appraisals and valuations for businesses are more complex, but the idea is the same. A business appraisal, also known as a valuation, is a form of economic analysis that aids in determining the true value of a company or professional practice. When a possible change of ownership of a company arises, the worth of the business must be decided.
What is the target use of a Business Appraisal or Valuation?
For a number of reasons, a business owner needs to know the true value of his or her assets. A business appraisal is a common requirement for obtaining a business loan. For instance, particularly if the lender is a traditional bank. A business valuation is often required for partnerships whether they are separating ownership, settling partnership disputes, or attempting to bring in a third party. If you’re gifting a portion or more of your business for estate planning purposes, you’ll need an estimate for tax purposes, much as you’d like to consider the worth of your house before selling it.
Business appraisals are not necessarily ordered by the owner. A business valuation may be required by a commercial lender, business owners, legal practitioners, tax officials, or even the courts, depending on the circumstances. The intent of the valuation, as well as who it is for, will influence the process used to determine its value.
Understanding the Main Differences in Business Valuation Approaches
A certified appraiser may use three approaches to determine the valuation of a company: the market approach, the income approach, and the asset approach. Each method will provide you with an estimate of the company’s worth but from a different perspective. Once you’ve assessed and incorporated the outcomes of all three, you’ll have a comprehensive business valuation.
- Market Approach – Competition is the driving force behind a market approach to setting the value of your company. The evaluator will look at similar businesses’ selling prices and use that data to estimate what your company is worth. This approach is very similar to the technique used in a home’s value appraisal.
- Income Approach – The income approach of a business valuation can be achieved through several methods. At its core, it’s the expected economic benefit and level of risk that would come from an investment in the business. Depending on the method used, the current cash flow will be capitalized, discounted, or multiplied to help determine the future financial value of the company.
- Asset Approach – This is easiest explained as being the sum of all of the tangible parts that make a business. What the asset approach does is hypothetically take all of the equipment, stock, and supplies and sell them separately to see what they would be worth. This dollar amount becomes a part of the business’ overall value to potential buyers or shareholders.
The Documentation Needed For an Accurate Business Valuation
For a professional appraiser to be able to conduct their research, a business owner will need to provide a certain amount of data, paperwork, and financial information. The more current and up-to-date documentation you can offer, the more accurate the business valuation. The quality and timeliness of the data are critical when trying to ensure that you are getting a defendable valuation number for the time, money, and effort you have put into building a business.
A list of the basic documentation you should be able to provide includes:
- Your current capital structure
- Your financial statements over the last three years
- Tax returns from the last three years
- The current year-to-date financial statements
- The profit and loss summaries from the last three years – quarterly if available
- A full list is provided here: Data needed for a Business Valuation
The business valuation analyst or appraiser will also ask you key questions about your business, such as your major product or service category, the sales process, customer profile, customer concentration, vendor concentration, and any major competitors. The number of full and part-time employees is needed along with a short description of those employees you rely on the most. Do you have key employees under non-compete agreements? You should be completely honest, open with your professional evaluator, and provide them with all the information requested to get a report that accurately represents your company’s worth.
Frequently Asked Questions
What Should a Business Valuation Report Contain?
When a professional appraisal is completed for your business, an extensive report is delivered that consists of much more than just numbers and financial data. A correctly executed business valuation will start with a summary of the purpose of the appraisal and its scope along with the expected recipient and the date.
After the summary, you should find a description of the current economic conditions concerning your industry on different levels. What follows are various analysis reports, including the financial statement, which provides the reader with an understanding of where the business stands economically in comparison to similar enterprises.
Who is qualified to appraise A Business?
For a business valuation to be considered valid, it must be performed by an uninterested third party. These valuation analysts are experts in interpreting data and trends to make a fair conclusion about the worth of a company or business. The results that the qualified business valuation analyst or appraiser provides you with should be both prompt and accurate so that you can proceed promptly with the transaction that initiated the business valuation in the first place. The typical designation is a CVA or Certified Valuation Analyst which all the business valuation analysts at Business Appraisal Florida holds.
Is a Business Valuation the Same as a Business Evaluation?
The primary purpose of a business appraisal is to determine a company’s financial value in the marketplace. A business valuation is looking at all assets concerning all risks and liabilities. An evaluation of a business measures the intangible, as it is assessing the operations of the business to see how effectively and consistently it generates cash flow. This type of business tool is typically utilized when an owner or management is trying to improve on cash flow or profits by improving productivity.
When Should a Business be Appraised?
A new business can typically wait about two years before having their first business valuation report executed unless they are venture or angel-capital-backed or are in hyper-growth mode. Having the first appraisal done in two years is a good idea, especially if competitors have been showing an interest in buying your company. Knowing the true value of your enterprise early on will also be helpful if you have expansion plans but need help in funding your growth. An accurate business appraisal can be used to help you get funding from a bank or other type of business lender.
Established businesses should have a professional business appraisal done every five to ten years or sooner if you are executing your exit strategy or approaching retirement age. Keep in mind that any time a vested partner opts to leave a business, a valuation will be needed to determine their fair share of the company. All Buy-Sell Agreements should reference two critical areas. 1. The Valuation Methodology or Valuation Firm to be used and 2. What is the funding mechanism to buy the exiting party out. If you intend on “gifting” shares to family members as a part of their inheritance, the IRS will want an arm’s length appraisal.
Whether looking for financing to expand your operations or to hand your legacy over to your heirs, an accurate business valuation is invaluable. Arm yourself with the full economic knowledge of your business now, and you will be in a better position to negotiate your price later. Call 561-325-9777 or email to find what your company is worth through our professional valuation services.