The 7 basic principles of business valuation

Principle # 1 : The value is determined at a specific point in time. It is a function of facts know and expectations made only at that point in time

The first principle in business valuation suggests that “value is a function of time.” [1]

To determine the fair market value (FMV) of a business, a chartered business valuator (CBV) must assign great importance to the valuation date. The valuation is based on the financial structure and future perspective of the business at a given date.

Valuation conclusions are valid for the valuation date only. Internal and external factors may change the value of the business. Consider, for example, a business valued at $ 1 million on January 31, 2017 for which the owner pays a dividend of $ 500,000 on February 1, 2017. All other things being equal, the value of the business will have significantly decreased with the payment of this dividend since, as at the valuation date, this amount was part of the available equity in the business.

[1] Translated from : Niveau 1 Cours d’introduction à l’évaluation d’entreprises de l’ICEEE, Automne/hiver 2016, p.M1-26

The date of valuation and the internal and external factors

When a business is appraised, some items are known or can be predicted:

• The assets of the business;
• The debts;
• Contracts value;
• Key employees;
• Future perspective;

That being said, you are aware that a business is constantly evolving. There is nothing static about it. There are changes within the business, whether it’s the financial structure, the key employees, the business model, etc., and changes outside of the business such as customers, suppliers, competitors, the economy in general, etc. For these reasons, the value of a business cannot be constant over time. A CBV evaluates the business with the information known and available on the date of valuation.

The date of valuation and the projections

Based on known or predictable facts as of the date of the valuation, a CBV can make certain predictions. The imminent signing of a major contract or a partnership to be finalized in the days following the valuation date may be facts that will enable the expert to make predictions about the future value of the business. However, it is important to understand that these projections have value only if they can be predicted at the valuation date.

A CBV can’t base its predictions on events that occurred after the valuation date and that were not predictable at the valuation date. For example, if the business has a product that is subject to a massive recall after the valuation date and that it was unpredictable on the valuation date then this can’t be considered in the valuation of the business on the valuation date. This is the case even if it makes the profits of the business and its value suffer.

Consequently, the valuation date can’t be taken lightly since the conclusions of the report are directly related to it.

To have your business appraised, contact me! I will be pleased to assist you in determining the fair market value of your business and to determine the appropriate valuation date to suit your needs.