How are Businesses Valued?
There are different valuation methodologies that a valuer may use depending on the specific of the business and the purpose of the valuation.
A Business Valuation expert will consider multiple valuation methodologies for the circumstances, however the more commonly used techniques for valuing smaller and medium sized companies are:
Capitalisation of Earnings Method
This method involves the multiplication of an Earnings figure by an appropriate Capitalisation Rate. Earnings are the assessed profits that can be derived by the business and excludes any one off items. Depending on the circumstances, the Earnings may be based on
EBIT – Earnings Before Interest and Tax and its derivations EBITA (EBIT before Amortisation) and EBITDA (EBIT before Depreciate and Amortisation)
PEBIT – Proprietors EBIT is EBIT before owner salaries and other benefits
Profit after Tax – used in listed company analysis as part of a price earnings ratio
Generally, a multiple of EBIT (or EBITA, EBITDA) is more common than either PEBIT or Profit After Tax. A PEBIT based Earnings is generally more suitable for very small businesses.
Market Value Method
The Market Approach is based on an analysis of the price of similar businesses in the market. The performance of the subject business is compared to other businesses and then a set of appropriate multiples are developed to be used in the valuation.
Discounted Cash Flow Method
An analysis of the net present value of the projected cash flows of a business (or Discounted Cash Flow Method) is a valuation technique based on the premise that the value of the business is the net present value of future cash flows. It requires an analysis of revenue, expenses, investment (cash balances, working capital movements, capital expenditure budgets), capital structure and cost of capital, and the residual remaining at the end of the forecast period.
Properly determining the value of a business is a complicated process. Consult with a professional business valuation expert that has technical and business experience, the ability to select the appropriate valuation techniques, and a thorough understanding of today’s tax laws, finance and market conditions. An unbiased business valuation serves as a benchmark, minimizes ownership disputes and provides a realistic, credible and defendable valuation for any business owner.
What Type of Valuation
When we are asked to value a business, our first few questions usually revolve around the purpose of the valuation and what type of valuation a client requires.
Depending on the circumstances, there are different types of valuations and some activities that some may call valuations are not actually valuations at all. As the veracity, reporting and costs of these different types of engagements may vary, it is imperative that the instructions are clear on the type and any limitation of the valuation.
Professional business valuers, such as Chartered Accountant Business Valuation Specialists, are obliged to comply with certain professional standards including any with APES 225 Valuation Services issued by Accounting Professional & Ethical Standards Board.
The types of valuations are: a Valuation, Limited Scope Valuation, or Calculation Engagement. APES 225 Valuation Services provides definitions of the different types of valuation engagements and gives examples of different types of valuation.
Calculation Engagement is a valuation engagement where the client determine the Valuation Approaches, Valuation Methods and Valuation Procedures that the valuer will employ. A Calculation Engagement generally does not include all of the Valuation Procedures required for a Valuation Engagement or a Limited Scope Valuation Engagement. An example may be the calculation of a share price based on a prescribed formula.
Limited Scope Valuation Engagement is a valuation engagement where the scope of work is limited or restricted. A limitation or restriction may be imposed by the Client or Employer or it may arise from other sources or circumstances. An example may be an internal indicative valuation where the industry is not analysed.
Valuation means the act or process of determining an estimate of value of a business, business ownership interest, security or intangible asset by applying Valuation Approaches, Valuation Methods and Valuation Procedures. This is the most comprehensive type of valuation which may be used for litigation purposes (such as family law and shareholder disputes, purchase price allocations and independent experts report on a takeover.
Another common so called “valuation” is for an estimate of a sale price of a business. As part of the business sale process, we may be asked to provide generic valuation statistics and parameters relevant to the industry in which the business operates. This is not a valuation, even if some valuation procedures are conducted as the engagement is to provide ancillary services related to the sale.
Business Valuation Process
The Process of a valuation will vary depending on the size, industry and profitability of the business, the reason for and date of the valuation. The typical steps in a valuation are as follows:
1) Business investigation An understanding of the business is attained through a thorough inspection of: the business, the relevant documents and data gathered from the owners and key staff (where applicable).
2) Analysing data collected Review data provided and external information to determine profitability trends, industry trends, opportunities/risks and external factors.
3) Determine value of the business Based on the information collected, consider different valuation methodologies to determine an appropriate valuation methodology and valuation of the business.
4) Preparation of the valuation report Prepare a valuation report outlining the valuation processes and justifications of the valuation.
Family Law Business Valuation
Endeavour Valuations has prepared a plain English guide to business valuations for Family Law matters. The guide is designed for your clients to obtain a better understanding of the reasons, process and outcome from a business valuation.
This guide can be obtained from the link below
Family Law Business Valuation Guide.pdf
Please feel free to pass this guide on to clients.
Business Valuations for Tax Purposes
A business owner may need to establish the Market Value of a business, security or intangible asset for tax purposes, including:
changes in capital structure
changes of ownership
capital gains tax rollovers
company divestments
company acquisitions
formation of a tax-consolidated group
entry to a tax-consolidated group
exit from a tax-consolidated group
small business capital gains tax concession
thin capitalisation.
The Australian Taxation Office has prepared some guidance on business valuations including the contents of valuation reports and Tax Office processes.
Taxpayers who undertake their own valuations or use valuations from people without adequate qualifications, experience and independence risk incorrectly reporting their tax liability and may be liable to pay administrative penalties.
The majority of taxpayers who use a qualified valuer or equivalent professional for taxation purposes will generally not be liable to a penalty if they have provided the valuer with accurate information where the valuation ultimately proves to be deficient.
Buying and Selling a Business
If you are considering selling your business, then you will probably want to get an estimate of the likely selling price. Technically this is not a valuation, although valuations techniques are used.
Ultimately the eventual selling price will be a result of negotiations between buyer and seller and this may be different from the estimate of selling price as other factors may come into play such as access to markets, financial pressure, eagerness of buyer or seller or illness
An estimate of selling price may assist the seller to negotiate the selling price and give them confidence to reject a low ball offer.
Building Value in your Business
One of the areas where valuations have been vastly under-utilised is as a management tool, particularly for family owned businesses.
We are constantly amazed at how few family business operators have an informed view on the value of their company. The owners often make business decisions and assumptions on exit and succession planning issues without having an informed starting point. In our opinion, all business owners should have a realistic view on the value of their business.
All business owners over 55 years old should have a valuation performed every few years. Once a valuation is established, then the business owner and their advisers can develop plans to increase its value and monitor their performance in increasing wealth.