The main approaches in business valuationJean-Claude Desnoyers
When you use the services of a Chartered Business Valuator (CBV), do you know what kind of work he will do to give you the most accurate assessment of the fair market value of a business? Do you have an idea of the questions he asks himself, the decisions he has to make, and based on which factors?
Depending on the business situation and available financial information, the CBV will choose one or more specific valuation methods to meet your needs. To help you better understand the main approaches used in business valuation, here is a general portrait of the three principal categories of valuation methods: asset-based, income-based and comparable transactions.
However, as I already mentioned here “How to make your own judgments on the quality of a business valuation report? “, the determination of the fair market value of a business is a complex task that requires specialized expertise. While this article will give you a good overview of the work done by a CBV, using the services of an expert is essential to get the most accurate assessment of the business you want to evaluate.
The first decision
Even before choosing one of the three main categories of valuation methods, the CBV must, when starting his evaluation, ask himself a first essential question: will he evaluate the business based on its going concern or liquidation value?
If the CBV chooses a method based on the liquidation value, he determines that the business is no longer viable. He will then have the choice between an orderly liquidation (if he has time to carry out the liquidation of the business, that will allow him to maximize its value) or the forced liquidation (if the assets of the business must be liquidated immediately).
If, on the contrary, the CBV determines that the business will continue to operate profitably or has a reasonable profitability perspective, he will choose a going concern method. In this case, he will appraise the business using specific techniques from one or more of the three main categories of business valuation methods.
Asset-based valuation methods
If the CBV decides to value a business as a going concern, he may use the net adjusted book value method. In this case, he will among other things, adjust the value of the assets and liabilities to their fair market value.
This valuation method will be preferred when there are no intangible assets within the business. For example, if the business’s income comes from a family doctor’s fee and the family doctor leaves the business, it will probably not have any more revenue. If this is the case, then there will be no intangible asset, and the fair market value of the business can be determined using the net adjusted book value method.
Income-based valuation methods
In this category of valuation methods, the CBV evaluates the value of a business based on its estimated future profitability. There are some valuation techniques that use the business’s past results to forecast future earnings (the capitalization of maintainable earnings or capitalization of maintainable cash flow) and others based on a projection of the business’s estimated results in the coming years (the discounted cash flow valuation method).
The choice to work with past or future financial results will depend on various factors, such as the level of maturity of the business. Are the business’s past results representative of what can be expected in the future? Has the business been established long enough to have access to the financial data for the last four to five years? Often, the purchase of capital assets will also influence the choice of an income-based method, as will be explained in more detail in an upcoming article.
Valuation methods based on comparable transactions
The last approach includes methods that rely on comparable data available in the market (the CBV evaluates the business by observing the results and transactions of other businesses in the same industry). There are transactional databases that allow comparisons: similar businesses are searched for, and their data is used to determine the value.
Some of these techniques are helpful, for example, when the CBV does not have sufficient financial information to use the other methods. However, these techniques are often used in conjunction with asset-based or revenue-based methods.
There are therefore many valuation methods to appraise a business, which makes it essential to have the help of an expert who is familiar with these approaches and who analyzes several factors before making decisions during his work. It should be noted that the CBV will often consider more than one technique to determine the most accurate fair market value of the business.
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