Industry-Wide Business Valuation FAQ & Glossary
Unless you are an M&A Professional, Tax CPA or Estate Planning Attorney, much of the audience for a business valuation is seeing the terms used throughout for the first time. And can be very confusing and difficult whether for the business owner, family members or stakeholders in a privately held company.
To both enhance and sustain the quality of business valuations for the benefit of the profession and its clientèle. The below-identified societies and organizations have adopted the definitions for the terms included in this glossary.
- American Institute of Certified Public Accountants
- American Society of Appraisers
- Canadian Institute of Chartered Business Valuators
- National Association of Certified Valuation Analysts
- The Institute of Business Appraisers
The performance of accredited or certified business valuation services requires a high degree of skill and imposes upon the valuation professional a duty to communicate the valuation process and conclusion in a manner that is clear and not misleading. This duty advance through the use of terms whose meanings are clearly established and consistently applied throughout the profession.
Whether the performance of accredited or certified business valuation services requires a high degree of skill and imposes upon the valuation professional a duty to communicate the valuation process and conclusion in a manner that is clear and not misleading. This duty advance through the use of terms whose meanings are both clearly established and consistently applied throughout the profession.
Business Valuation Glossary
This glossary had developed to guide business valuation practitioners by further honoring the body of knowledge consequently. Which composes the competent and careful determination of value and, particularly, and the communication of how that value determines. Departure from this glossary does not intend to provide a basis for civil liability. And should not presume to create evidence that any duties have breached.
Note: this glossary is reproduced verbatim from the International Glossary of Business Valuation Terms with additional small business valuation terms from Business Appraisal FL|GA for clarity. The Glossary of Additional Valuation terms had add in alphabetical order to improve readability.
A
Add-backs — Many privately owned businesses are running to minimize taxes. The expense items that add back to the business’s net pretax operating profit are add-backs. This arrive at an accurate estimation of the business’s profitability. Potential Buyers of a business should pay special attention to these. They should look for legitimate adjustments in the other direction, normalized owner’s salaries or market rents. Add-backs always come from the Profit and Loss Statement.
Adjusted Book Value Method — A method within the asset approach assets and liabilities (including off-balance sheet, intangible, and contingent) adjust to their fair market values. {NOTE: In Canada on a going concern basis}
Adjusted Net Asset Method – see Adjusted Book Value Method.
Appraisal — see Valuation.
An Appraisal Approach — see Valuation Approach.
The Appraisal Date — see Valuation Date.
Appraisal Method — see Valuation Method.
Appraisal Procedure — see Valuation Procedure.
Arbitrage Pricing Theory — a multivariate model for estimating the cost of equity capital, which contains several systematic risk factors.
Asset (Asset-Based) Approach — a way of determining a value indication of a business ownership interest or security using one or more methods based on the value of the assets net of liabilities.
Assumptions and Limiting Conditions — Parameters and boundaries under a valuation are whether performed, agreed upon, acknowledged, or understood by both the valuation analyst and the client as being due to existing circumstances. An example is an acceptance without further verification, in which the valuation analyst from all the client’s financial statements and related information.
B
Beta — a measure of the systematic risk of a stock. And is the tendency of a stock’s price to connect with changes in a specific index.
Blockage Discount — An amount or percentage deducted from the current market price of a publicly-traded stock. To reflect the decrease in the per-share value of a block of stock of a size that could not sell in a reasonable period given a trading volume. Book Value—see Net Book Value.
Business — see Business Enterprise.
- Business Enterprise — a commercial, industrial, service, or investment entity (or a combination thereof) pursuing an economic activity.
- Business Ownership Interest — A designated share in the ownership of a business (business enterprise).
- Business Risk — the degree of uncertainty in realizing the expected future returns of the business. That results from factors other than financial leverage. See Financial Risk.
Business Valuation — the act or process of determining the value of either a business enterprise or ownership interest therein.
C
Calculated Value — An estimated value of a business, business ownership interest, security, or intangible asset. Arrived by applying valuation procedures agreed upon with the client and using professional judgment. The value or range of values based on those procedures.
Calculation Engagement — An engagement to estimate value wherein the valuation analyst and the client agree on the specific valuation approaches and methods. That the valuation analyst will use and the extent of valuation procedures the valuation analyst will perform to estimate the value of a subject interest. A calculation engagement generally does not include all of the valuation procedures required for a valuation engagement. If a valuation engagement has performed, the results might have been different. The valuation analyst expresses the results of the calculation engagement as a calculated value. And may be either a single amount or a range.
Capital Asset Pricing Model (CAPM) — a model in which the cost of capital for any stock or portfolio equals a risk-free rate. A risk premium proportionate to the systematic risk of the stock or portfolio.
Capitalization Methods
- Capitalization of Benefits Method — It is a method within the income approach whereby expected future benefits (for example, earnings or cash flow). For a single representative, period converts to value through division by a capitalization rate.
- Capitalization of Earnings Method — It is a method within the income approach whereby economic benefits for a single representative period. That converts to value through division by a capitalization rate.
Capitalization Rate — any divisor (usually expressed as a percentage) used to convert anticipated economic benefits of a single period into value.
Capital Structure — the composition of the invested capital of a business enterprise; the mix of debt and equity financing.
Cash Flow — cash generated over time by an asset, group of assets, or business enterprise. And may use in a general sense to encompass various levels of specifically defined cash flows. When using the term, it should insert by a qualifier. (for example, “discretionary” or “operating”) and a specific definition in the given valuation context.
Common Size Statements — financial statements in which each line expresses a percentage of the total. On the balance sheet, each line item shows a percentage of total assets. Also, on the income statement, each item expresses as a percentage of sales.
Capital or Contributory Asset Charge — A fair return on an entity’s contributory assets is tangible and intangible assets. And uses in producing income or cash flow associated with an intangible asset valued. In this context, income or cash flow refers to an applicable measure of income or cash flow. These are net income, operating cash flow before taxes and capital expenses. A capital charge may express a percentage return on an economic rent associated with or a profit split related to the related assets.
Related Terms:
-
Capitalization — a conversion of a single period of economic benefits into value.
-
Capitalization Factor — any multiple or divisor used to convert anticipated economic benefits of a single period into value.
Comparable Profits Method — A method of determining the value of intangible assets. By comparing the profits of the subject entity. With those of similar uncontrolled companies that have the same or similar complement of intangible assets as the subject company.
Comparable Uncontrolled Transaction Method — A method of determining the value of intangible assets. By comparing the subject transaction to similar transactions. In the marketplace made between independent (uncontrolled) parties.
Conclusion of Value — an estimate of the value of a business, business ownership interest, security, or intangible asset. And arrived at by applying valuation procedures appropriate for a valuation engagement. And using professional judgment as to the value or range of values based on those procedures.
Control — the power to direct the management and policies of a business enterprise.
Control Adjustment — A valuation adjustment to financial statements to reflect the effect of a controlling interest in a business. An example would be an adjustment to owners’ compensation that is in excess of market compensation.
Cost Approach — a general way of determining a value indication of an individual asset. By measuring the amount of money required to replace the future service capability of that asset.
Cost of Capital — the expected rate of return that the market. And requires in order to attract funds to a particular investment.
D
Debt-free — we discourage the use of this term. See Invested Capital.
Discount for Lack of Control — an amount or percentage deducted from the pro rata share of value. A 100% in equity interest in a business reflects the absence of either some or all of the powers to control.
Discount for Lack of Marketability — an amount or percentage deducted from the value of an ownership interest. Reflect the relative absence of marketability.
Discount for Lack of Voting Rights — an amount or percentage deducted from the per share value of a minority interest. Voting share to reflect the absence of voting rights.
Discount Rate — a rate of return used to convert a future monetary sum into present value.
Discounted Cash Flow Method — a method within the income approach whereby uses a discount rate. It calculates the present value of future expected net cash flows.
Discounted Future Earnings Method — a method within the income approach whereby uses a discount rate. And calculates the present value of future expected economic benefits.
E
Economic Benefits — inflows such as revenues, net income, and net cash flows, etc.
Economic Life — the period of time over which property may generate economic benefits.
Effective Date — see Valuation Date.
Engagement to Estimate Value — An engagement, or any part of an engagement, (for example, a tax, litigation, or acquisition-related engagement). And it involves determining the value of the business, business ownership interest, security, or intangible asset. Also known as valuation service.
Enterprise — see Business Enterprise.
Equity — the owner’s interest in property after deduction of all liabilities.
Equity Net Cash Flows — those cash flows available to pay out to equity holders (in the form of dividends). After funding operations of the business enterprise, making both necessary capital investments, and increasing or decreasing debt financing.
Excess Earnings — that amount of anticipated economic benefits that exceeds an appropriate rate of return. On the value of a selected asset base (often net tangible assets) used to generate those anticipated economic benefits.
Excess Earnings Method — a specific way of determining a value indication of a business, business ownership interest, or security determined. As the sum of a) the value of the assets derived by capitalizing excess earnings and b) the value of the selected asset base. Also frequently used to value intangible assets. See Excess Earnings.
Excess Operating Assets — Operating assets in excess of those needed for the normal operation of a business.
F
Fair Market Value — the price, in terms of cash equivalents, at which property changes hands between a hypothetical willing and able buyer and seller. In acting at arm’s length in an open and unrestricted market. When neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts. {NOTE: In Canada, the term “price” should replace with the term “highest price”.}
Fairness Opinion — an opinion as to whether or not the consideration in a transaction is fair from a financial point of view.
Fair Value — In valuation applications, there are two commonly used definitions for fair value:
(1) For financial reporting purposes only. The price whether that would receive to sell an asset or paid to transfer a liability. In an orderly transaction between market participants at the measurement date. Source: Financial Accounting Standards Board Accounting Standards Codification glossary.
(2) For state legal matters only. Some states have laws that use the term fair value in both shareholder and partner matters. For state legal matters only, the term may define by statute or case law in the particular jurisdiction.
Financial Risk — the degree of uncertainty of realizing expected future returns of the business resulting from financial leverage. See Business Risk.
Forced Liquidation Value — liquidation value, in which the assets at an auction sells as quickly as possible.
Free Cash Flow — we discourage the use of this term. See Net Cash Flow.
G
Going Concern — an ongoing operating business enterprise.
Going Concern Value — the value of a business enterprise that expects to continue to operate into the future. The intangible elements of Going Concern Value result from factors. Such as having a trained workforce, an operational plant, and the necessary licenses, systems, and procedures in place.
Goodwill — that intangible asset arising as a result of name, reputation, customer loyalty, location, products, and similar factors not separately identified.
Goodwill Value — the value attributable to goodwill.
Guideline Company Transactions Method — A method within the market approach whereby market multiples are derived. From the sales of entire companies engaged in the same or similar lines of business.
Guideline Public Company Method — a method within the market approach whereby market multiples are derived. From market prices of stocks of companies that engages in the same or similar lines of business. That are also actively traded on a free and open market.
H
Hypothetical Condition — That which is or may be contrary to what exists, but suppose for the purpose of analysis.
I
Income (Income-Based) Approach — a general way of determining a value indication of a business, business ownership interest, security, or intangible asset. Uses one or more methods that convert anticipated economic benefits into a present single amount.
Incremental Income — Additional income or cash flow is attributable to an entity’s ownership or operation of an intangible asset valued. As determined by a comparison of the entity’s income or cash flow with the intangible asset to the entity’s income or cash flow without the intangible asset. In this context, income or cash flow refers to an applicable measure of income or cash flow. Such as license royalty income or operating cash flow before taxes and capital expenditures.
Intangible Assets — nonphysical assets such as franchises, trademarks, patents, copyrights, goodwill, equities, mineral rights, securities, and contracts (as distinguished from physical assets). That grant rights and privileges and have value for the owner.
Invested Capital Net Cash Flows — those cash flows available to pay out to equity holders (in the form of dividends) and debt investors (in the form of principal and interest). After funding operations of the business enterprise and making necessary capital investments.
Related Terms:
- Investment Risk — the degree of uncertainty as to the realization of expected returns. Investment Value— the value to a particular investor based on individual investment requirements and expectations. {NOTE: in Canada, the term used is “Value to the Owner”.}
- Investment Value — the value to a particular investor based on individual investment requirements and expectations. {NOTE: in Canada, the term used is “Value to the Owner.”}
Internal Rate of Return — a discount rate at which the present value of the future cash flows of the investment equals the cost of the investment.
Intrinsic Value — the value that an investor considers, on the basis of an evaluation or available facts. To be the “true” or “real” value that will become the market value. When other investors reach the same conclusion. When the term applies to options, it is the difference between the exercise price and strike price of an option and the market value of the underlying security.
Invested Capital — the sum of equity and debt in a business enterprise. Debt is typically (a) all interest-bearing debt or (b) long-term, interest-bearing debt. When using the terms, they should supplement by a specific definition in the given valuation context.
K
Key Person Discount — an amount or percentage deducted from the value of an ownership interest. To reflect the reduction in value resulting from the actual or potential loss of a key person in a business enterprise.
L
Levered Beta — the beta reflecting a capital structure that includes debt.
Limited Appraisal — the act or process of determining the value of a business, business ownership interest, security, or intangible asset with limitations in analysis, procedures, or scope.
Liquidity — the ability to quickly convert the property to cash or pay a liability.
Liquidation Value — the net amount that would realize if the business terminates and the assets sold piecemeal. Liquidation can be either “orderly” or “forced.”
M
Majority Control — the degree of control provided by a majority position.
Majority Interest — an ownership interest greater than 50% of the voting interest in a business enterprise.
Market (Market-Based) Approach — a general way of determining a value indication of a business, business ownership interest, security, or intangible asset. By using one or more methods that compare the subject to similar businesses, business ownership interests, securities, or intangible assets that have been sold.
Related Terms:
- Market Capitalization of Equity — the share price of a publicly traded stock multiplied by the number of shares outstanding.
- Market Capitalization of Invested Capital — Widely used to measure the value of small businesses. Market Value of Invested Capital or Market Capitalization of Invested Capital, abbreviated to MVIC. Represents the value of the total capital invested in the company. This covers the business tangible assets and goodwill, which may be financed by the business owners or their creditors. The market capitalization of equity plus the market value of the debt component of invested capital.
Market Multiple — the market value of a company’s stock or invested capital divided by a company measure (such as economic benefits, number of customers).
Marketability — the ability to quickly convert property to cash at minimal cost.
Marketability Discount — see Discount for Lack of Marketability.
Merger and Acquisition Method — a method within the market approach whereby pricing multiples are derived. From transactions of significant interests in companies engaged in the same or similar lines of business.
Mid-Year Discounting — a convention used in the Discounted Future Earnings Method. That reflects economic benefits being generated at midyear. Approximating the effect of economic benefits being generated evenly throughout the year.
Minority Discount — a discount for lack of control applicable to a minority interest.
Minority Interest — an ownership interest less than 50% of the voting interest in a business enterprise.
Multiple — the inverse of the capitalization rate.
N
Net Book Value — with respect to a business enterprise. The difference between total assets (net of accumulated depreciation, depletion, and amortization) and total liabilities as they appear on the balance sheet (synonymous with Shareholder’s Equity). With respect to a specific asset. The capitalized cost less accumulated amortization or depreciation as it appears on the books of account of the business enterprise.
Net Cash Flows — when the term is used, and should be supplemented by a qualifier. See Equity Net Cash Flows and Invested Capital Net Cash Flows.
Net Present Value — the value, as of a specified date, and of future cash inflows less all cash outflows (including the cost of investment). Calculated using an appropriate discount rate.
Net Tangible Asset Value — the value of the business enterprise’s tangible assets (excluding excess assets and non-operating assets). Minus the value of its liabilities.
Non-Operating Assets — assets not necessary to ongoing operations of the business enterprise. {NOTE: in Canada, the term used is “Redundant Assets”.}
Normalization — See Normalized Earnings.
Normalized Earnings — economic benefits adjusted for nonrecurring, noneconomic, or other unusual items to eliminate anomalies and/or facilitate comparisons.
Normalized Financial Statements — financial statements adjusted for non-operating assets and liabilities and/or for nonrecurring, noneconomic, or other unusual items to eliminate anomalies and/or facilitate comparisons.
O
Orderly Liquidation Value — liquidation value at which the asset or assets are sold over a reasonable period to maximise the received proceeds.
P
Portfolio Discount — an amount or percentage deducted from the value of a business enterprise. To reflect the fact that it owns either dissimilar operations or assets that do not fit well together.
Pre-adjustment value — The value arrived at prior to the application, if appropriate, whether of valuation discounts or premiums.
Premise of Value — an assumption regarding the most likely set of transactional circumstances that may be applicable to the subject valuation; for example, going concern, and liquidation.
Present Value — the value, as of a specified date, of future economic benefits and/or proceeds from sale, calculated using an appropriate discount rate.
Price/Earnings Multiple — the price of a share of stock divided by its earnings per share.
Profit Split Income — profit split income. With respect to the valuation of an intangible asset of an entity, a percentage allocation of the entity’s income or cash flow whereby (1) a split (or percentage) is allocated to the subject intangible and (2) the remainder is allocated to all of the entity’s tangible and other intangible assets. In this context, whether income or cash flow refers to an applicable measure of income or cash flow, such as net income or operating cash flow before taxes and capital expenditures.
R
Rate of Return — an amount of income (loss) and/or change in value realized or anticipated on an investment, expressed as a percentage of that investment.
Redundant Assets — see Non-operating Assets.
Relief from Royalty Method — A valuation method used to value certain intangible assets (for example, trademarks and trade names) based on the premise that the only value that a purchaser of the assets receives is the exemption from paying a royalty for its use.
Application of this method usually involves estimating the fair market value of an intangible asset by quantifying the present value of the stream of market–derived royalty payments that the owner of the intangible asset is exempted from or “relieved” from paying.
Report Date — the date conclusions are transmitted to the client.
Replacement Cost New — the current cost of a similar new property having the nearest equivalent utility to the property being valued.
Reproduction Cost New — the current cost of an identical new property.
Required Rate of Return — the minimum rate of return acceptable by investors before they will commit money to an investment at a given level of risk.
Residual Income — For an entity that owns or operates an intangible asset being valued, the portion of the entity’s income or cash flow remaining after subtracting a capital charge on all of the entity’s tangible and other intangible assets. Income or cash flows can refer to any appropriate measure of income or cash flow, such as net income or operating cash flow before taxes and capital expenditures.
Residual Value — the value as of the end of the discrete projection period in a discounted future earnings model. Return on Equity—the amount, expressed as a percentage, and earned on a company’s common equity for a given period.
Related Terms:
-
Return on Equity — the amount, expressed as a percentage, and earned on a company’s common equity for a given period.
-
Return on Investment — See Return on Invested Capital and Return on Equity.
-
Return on Invested Capital — the amount, expressed as a percentage, and earned on a company’s total capital for a given period.
Risk-Free Rate — the rate of return available in the market on an investment free of default risk.
Rule of Thumb — a mathematical formula developed from the relationship between both price and certain variables based on experience, whether an observation, hearsay, or a combination of these; usually industry-specific.
Rule of Thumb Business Valuation — Every type of business has three or more different valuation rules of thumb that are used to give a ballpark value. There are thousands of different rules of thumb that are available to provide an indication of value for different business types. These “rules” are based on some multiple of sales, EBITDA or growth rate.
S
Sales to Working Capital — The working capital turnover ratio is also referred to as net sales to working capital. It indicates a company’s effectiveness in using its working capital, and this ratio often highlights trends missed by current and quick ratios. The working capital turnover ratio is calculated by net annual sales divided by the average amount of working capital during the same year.
Security — A certificate evidencing ownership or the rights to ownership in a business enterprise that (1) is represented by an instrument or by a book record or contractual agreement, (2) is of a type commonly dealt in on securities exchanges or markets or when represented by an instrument, is commonly recognized in any area in which it is issued or dealt in as a medium for investment, and (3) either one of a class or series or, by its terms, is divisible into a class or series of shares, participations, interests, rights, or interest-bearing obligations.
Special Interest Purchasers — acquirers who believe they can enjoy either post-acquisition economies of scale, synergies, or strategic advantages by combining the acquired business interest with their own.
Standard of Value — the identification of the type of value being utilized in a specific engagement; for example, fair market value, fair value, investment value.
Subject Interest — A business, business ownership interest, security, or intangible asset subject to a valuation engagement.
Subsequent Event — An event that occurs subsequent to the valuation date.
Sustaining Capital Reinvestment — the periodic capital outlay required to maintain operations at existing levels and net of the tax shield available from such outlays.
Systematic Risk — the risk that is common to all risky securities and cannot be eliminated through diversification. The measure of systematic risk in stocks is the beta coefficient.
T
Tangible Assets — physical assets (such as cash, accounts receivable, inventory, property, plant and equipment, etc.).
Terminal Value — See Residual Value.
Transaction Method — See Merger and Acquisition Method.
U
Unlevered Beta — the beta reflecting a capital structure without debt.
Unsystematic Risk — the risk specific to an individual security that can be avoided through diversification.
V
The Valuation — the act or process of determining the value of a business, business ownership interest, security, or intangible asset.
Valuation Analyst — For purposes of this statement, an AICPA member who performs an engagement to estimate value that culminates in the expression whether of a conclusion of value or a calculated value.
The Valuation Approach — a general way of determining a value indication whether of a business, business ownership interest, security, or intangible asset using one or more valuation methods.
Valuation Assumptions — Statements or inputs utilized in the performance of an engagement to estimate value that serve as a basis for the application of particular valuation methods.
The Valuation Date — the specific point in time as of which the valuator’s opinion of value applies (also referred to as “Effective Date” or “Appraisal Date”).
Valuation Engagement — An engagement to estimate value in which a valuation analyst determines an estimate of the value of a subject interest. By performing appropriate valuation procedures as outlined in the AICPA Statement on Standards for Valuation Services, and is free to apply the valuation approaches and methods he or she deems appropriate in the circumstances. The valuation analyst expresses the results of the valuation engagement as a conclusion of value, which may be neither a single amount nor a range.
Related Terms:
- Valuation Method — within approaches, a specific way to determine value.
- Valuation Procedure — the act, manner, and technique of performing the steps of an appraisal method.
- Valuation Ratio — a fraction in which a value or price serves as the numerator and financial, whether operating, or physical data serve as the denominator.
Valuation Service — See engagement to estimate value.
Value to the Owner — see Investment Value.
Voting Control — de jure control of a business enterprise.
W
Weighted Average Cost of Capital (WACC) — the cost of capital (discount rate) determined by the weighted average, at market value, and of the cost of all financing sources in the business enterprise’s capital structure.
Third Party Valuation Reports from Business Appraisal FL|GA
Taking the above definitions in mind, a professionally prepared valuation report is so much more than just a number or range of numbers. Our reports provide comprehensive business intelligence for the user. Business intelligence such as:
- A complete narrative of the subject company’s background, history, operations, key employees, customers and suppliers
- Complete financial analysis to highlight current, historical and future trends
- Complete ratio analysis to understand financial strengths and potential areas for improvement
- Economic and Industry outlooks which can identify new markets and channels for immediate and future growth
- Industry peer analysis which can illustrate competitive advantages, management strengths and opportunities for enhancement
- Full range of price justifications taking into account all of the potential types of users be they academic, financial or strategic.
- Supported and justified marketability and minority discounts when applicable
Please contact us or call (561) 882-1331 to discuss your specific needs or for an example Business Appraisal.
As a business owner, do you need help with your business valuation steps? Please call or contact BA F|G.