It has been said in the world of navigation that “before you chart a course for where you’re going, you must first determine where you are.” Such an adage would appear to be true in managing a business, as well. Without knowing vital information such as spending, inventory, or forecasts, we would all be shooting in the dark when it comes to developing a successful business strategy. And a tremendously helpful tool for determining these corporate vitals is a Business Valuation.
Whether your goals are to buy, sell, or improve upon your current business, determining its value will set a course for making your idea a reality and further set the tone for its success. And with multiple approaches to determining your company’s value, you can effectively and accurately assess its current capital structure so as to optimize the Business Enterprise Value.
Also known as “The Cost Approach,” the Asset Approach is rooted in the principle of substitution, which states that a prudent investor would pay no more for an existing business than the cost to replace its underlying assets new. This is especially useful when considering the startup costs for creating a new business from scratch; acquiring new equipment, supplies, facilities, or other imperative elements for conducting business as usual. Essentially, the asset approach compares the cost of purchasing “used versus new.” In this scenario, all tangible assets are assessed based on the cost to replace them with a new asset, minus allowances for physical depreciation, and any functional and economic obsolescence. Intangible assets that are self-created, as opposed to acquired, typically do not appear on the balance sheet, as their cost to create is usually expensed rather than capitalized. Furthermore, estimating the cost to replace intangible assets can be problematic, as reliable historical cost information may not be available. Similarly, liabilities are typically carried at face (versus market) value while contingent liabilities, like intangibles, may not be posted on the balance sheet. The nature of this approach makes it an appropriate choice for companies considering liquidation as a strategy, or whose assets can be readily monetized, such as real estate or investment holding companies.
As the name implies, the Market Approach considers identical or directly comparable assets (and liabilities) in the marketplace, to derive a value amount for the business. Value is estimated by a process of comparison and correlation between the subject asset and other similar assets, either on an individual or aggregate basis. Assets are typically sold in aggregate as a going concern business, with price indications based on sales of entire companies or fractional interests therein. Considerations such as time and conditions of sale are analyzed and adjusted. The market approach is most suitable when it is possible to identify a marketplace for the assets being appraised. Implied valuation multiples are computed for the comparable assets and used as a baseline for comparison with the subject assets. Differences in size, growth, profitability, leverage, and other investment risk characteristics are analyzed to determine appropriate multiples for the subject assets.
The Income Approach can take different forms, such as discounted cash flow or capitalization of cash flow methods. The appropriate form depends on the nature of the business and the industry in which it competes, as well as its stage of development. This method requires the estimation of either future cash flows over a discrete time period, or a normalized level of cash flow along with an estimate of a long-term growth rate.
With so many areas of focus to consider, accuracy and thoroughness are of utmost importance in determining Business Enterprise Value. At Appraisal Economics, we’ve helped a multitude of companies as their valuation expert, from Fortune 500 caliber companies to small, privately held firms. Speak with one of our professional team members today and to see how we can help your company.