Business Valuation

The value of a company's business enterprise is valuable and necessary information for management. For public companies, business valuations are necessary for compliance with numerous Accounting Standards Codifications (ASCs), including ASC 350 "Intangibles – Goodwill and Other." For private companies, knowing the business enterprise value is a necessary step when dealing with gift and estate taxes, stock compensation, for possible sale of the company or equity interests in it, and for capital structuring. Below is a brief mathematical derivation of business enterprise value and the three approaches and associated methods we use to calculate it.

We define the value of a business enterprise as the value of its net working capital plus the value of its fixed and intangible assets. This equates to the value of the total capital of the business (debt plus equity). We derive this relationship from the familiar accounting equation:

Assets = Liabilities + Stockholders' Equity

or, more specifically

CA + TFA + IA = CL + LTD + SE

where:

Rearranging the above equation, we have:

(CA - CL) + TFA + IA = LTD + SE

We define the quantity (CA - CL) as net working capital (NWC), and as previously defined, the business enterprise value equals net working capital plus fixed and intangible assets, so that:

Business Enterprise Value = NWC + TFA + IA = LTD + SE

Thus the business enterprise value equals the value of the company's debt plus its equity.

There are three principal approaches for determining the business enterprise value of a company: the income, market, and cost approaches.

The income approach uses valuation techniques to convert future benefits to a single, discounted amount. The measurement is based on the value indicated by current market expectations about those future amounts. Valuation techniques include single and multi-period capitalization of cash flow models, option-pricing models such as the Black-Scholes-Merton formula, and binomial (lattice) models.

The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities. Using this method, we rely upon stock prices of public companies similar to the subject company, and transaction prices of similar companies. We typically develop a relationship between the market value of the guideline companies to its revenue and earnings. Then we use these relationships, commonly referred to as valuation multiples, to value the subject company. We multiply the subject company's revenue or earnings income by the valuation multiples to obtain an indication of the business enterprise value.

The cost approach is based on the principle of substitution, and postulates that a prudent buyer would pay no more for an asset than the cost to replace the service capacity of that asset. In accordance with generally accepted accounting principles, assets are generally recorded at historical cost less accumulated depreciation. Intangible assets may or may not be included on historical balance sheets. Liabilities are reflected at face value, while contingent liabilities are generally not shown. Due to this accounting treatment, the use of book value of the assets and liabilities to estimate the fair market value of the equity may result in a material misstatement of fair market value. The cost approach is most useful when applied to the valuation of real estate companies, holding companies, heavy manufacturing, and companies for which liquidation is a likely prospect.

Appraisal Economics has significant experience valuing business enterprises, from Fortune 500 companies to smaller privately held family businesses. We can value the company in its entirety (debt and equity), value the equity, debt, and options, separately, and value underlying assets, such as real estate, machinery and equipment, and intangibles. Whether it's for gift and estate tax planning, compliance with Accounting Standards Codifications, or for an anticipated sale, and regardless of the intended audience (Internal Revenue Service, Securities & Exchange Commission, potential buyers, shareholders) Appraisal Economics has the personnel, expertise, and research resources required to provide the comprehensive business valuations necessary.