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. It can be very confusing and perplexing for the business owner, family members or stakeholders in a privately held company.
To 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 is advanced through the use of terms whose meanings are clearly established and consistently applied throughout the profession.
If in the opinion of the business valuation professional, one or more of these terms needs to be used in a manner that materially departs from the enclosed definitions, it is recommended that the term be defined as used within that valuation engagement.
This glossary has been developed to provide guidance to business valuation practitioners by further memorializing the body of knowledge that constitutes the competent and careful determination of value and, more particularly, the communication of how that value was determined. Departure from this glossary is not intended to provide a basis for civil liability and should not be presumed to create evidence that any duty has been 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 has been added in alphabetical order to improve readability.
Add-backs — Since many privately owned businesses are ran to minimize taxes, add-backs are expense items that are added back to the business net pretax operating profit in order to arrive at an accurate estimate of the business profitability. Potential Buyers of a business should pay special attention to these and also look for any legitimate adjustments in the other direction like 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 whereby all assets and liabilities (including off-balance sheet, intangible, and contingent) are adjusted 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.
Appraisal Approach — see Valuation Approach.
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 incorporates several systematic risk factors.
Asset (Asset-Based) Approach — a general way of determining a value indication of a business, 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 which a valuation is performed, as agreed upon by the valuation analyst and the client or as acknowledged or understood by the valuation analyst and the client as being due to existing circumstances. An example is the acceptance, without further verification, by the valuation analyst from the client of the client’s financial statements and related information.
Beta — a measure of systematic risk of a stock; the tendency of a stock’s price to correlate 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 that is of a size that could not be sold in a reasonable period of time given normal 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 of realizing expected future returns of the business resulting from factors other than financial leverage. See Financial Risk.
Business Valuation — the act or process of determining the value of a business enterprise or ownership interest therein.
Calculated Value — An estimate as to the value of a business, business ownership interest, security, or intangible asset, arrived at by applying valuation procedures agreed upon with the client and using professional judgment as to 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 valuation 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 had been performed, the results might have been different. The valuation analyst expresses the results of the calculation engagement as a calculated value, which 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 of stocks equals a risk-free rate plus a risk premium that is proportionate to the systematic risk of the stock or portfolio.
Capital or Contributory Asset Charge — A fair return on an entity’s contributory assets, which are tangible and intangible assets used in the production of income or cash flow associated with an intangible asset being valued. In this context, 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. A capital charge may be expressed as a percentage return on an economic rent associated with, or a profit split related to, the contributory assets.
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.
Capitalization of Benefits Method — A method within the income approach whereby expected future benefits (for example, earnings or cash flow) for a representative single period are converted to value through division by a capitalization rate.
Capitalization of Earnings Method — a method within the income approach whereby economic benefits for a representative single period are converted 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 that is generated over a period of time by an asset, group of assets, or business enterprise. It may be used in a general sense to encompass various levels of specifically defined cash flows. When the term is used, it should be supplemented 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 is expressed as a percentage of the total. On the balance sheet, each line item is shown as a percentage of total assets, and on the income statement, each item is expressed as a percentage of sales.
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 market place made between independent (uncontrolled) parties.
Conclusion of Value — An estimate of the value of a business, business ownership interest, security, or intangible asset, arrived at by applying the 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 quantifying 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 requires in order to attract funds to a particular investment.
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 of 100% of an equity interest in a business to reflect the absence of some or all of the powers of control.
Discount for Lack of Marketability — an amount or percentage deducted from the value of an ownership interest to 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 the present value of future expected net cash flows is calculated using a discount rate.
Discounted Future Earnings Method — a method within the income approach whereby the present value of future expected economic benefits is calculated using a discount rate.
Economic Benefits — inflows such as revenues, net income, 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), that involves determining the value of a 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 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.
Fair Market Value — the price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arms 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 be replaced 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 that would be received 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 shareholder and partner matters. For state legal matters only, therefore, the term may be defined 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, at which the asset or assets are sold as quickly as possible, such as at an auction.
Free Cash Flow — we discourage the use of this term. See Net Cash Flow.
Going Concern — an ongoing operating business enterprise.
Going Concern Value — the value of a business enterprise that is expected 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 are engaged in the same or similar lines of business and that are actively traded on a free and open market.
Hypothetical Condition — That which is or may be contrary to what exists, but is supposed for the purpose of analysis.
Income (Income-Based) Approach — a general way of determining a value indication of a business, business ownership interest, security, or intangible asset using one or more methods that convert anticipated economic benefits into a present single amount.
Incremental Income — Additional income or cash flow attributable to an entity’s ownership or operation of an intangible asset being 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.
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 the term is used, it should be supplemented by a specific definition in the given valuation context.
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.
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.”}
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.
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 property to cash or pay a liability.
Liquidation Value — the net amount that would be realized if the business is terminated and the assets are sold piecemeal. Liquidation can be either “orderly” or “forced.”
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.
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 Capitalization of Invested Capital or Market Value 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 both of 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.
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, it 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, 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.
Orderly Liquidation Value — liquidation value at which the asset or assets are sold over a reasonable period of time to maximize proceeds received.
Portfolio Discount — an amount or percentage deducted from the value of a business enterprise to reflect the fact that it owns dissimilar operations or assets that do not fit well together.
Pre-adjustment value — The value arrived at prior to the application, if appropriate, 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, 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, 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.
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, earned on a company’s common equity for a given period.
Return on Equity — the amount, expressed as a percentage, 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, 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 price and certain variables based on experience, 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.
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. This ratio will often highlight trends missed by current and quick ratios. The working capital turnover ratio is calculated as follows: 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 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 that is the subject of 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, 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.
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.
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.
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 of a conclusion of value or a calculated value.
Valuation Approach — a general way of determining a value indication 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.
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 either a single amount or a range.
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, 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.
Weighted Average Cost of Capital (WACC) — the cost of capital (discount rate) determined by the weighted average, at market value, 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.
Need help with your business valuation steps? Please call or contact BA F|G.