Valuing a Business
A business valuation is not the amount a business is guaranteed to sell for. Simply put; a valuation is the opinion from an expert, who understands the industry in which the assets are being valued and has acquired (through thorough investigation) all required data and facts about the business being valued. After this, the expert will then evaluate the data and perform a comparison between the internal and external forces that affect the enterprise. By analysing these forces (along with the market data, historical sales and other possible investments compared to the business); the valuer can then establish their belief on what the business is worth.
The emphasis here is on expert opinion and possible business value. The only way to determine the exact value of the business is to arrange an arms length transaction of that business.
The international value standards (IVS) refer to market value as follows: “Market value is the estimate and amount for which an asset is to exchange on the date of valuation between a willing buyer, and willing seller, in an arms length transaction wherein each of the parties has acted knowledgeably prudently and without compulsion.”
Bearing all of these facts in mind, it is crucial that when choosing someone to perform a business valuation; one must find the right expert who will be able to produce a logical and factual Valuation. That is backed by evidence, to help you through your decision process or resolution; quickly and efficiently.
Methods of Valuation
There are three main recognised methods used by Perth business valuers and these are the Asset Based, Income Based and Market Based approaches.
Asset Based Approach:
The Asset-Based approach is often called the “Cost Approach” or the “Replacement Cost Approach”. In this approach, each component of the business is valued separately and the asset values are totaled. The Asset-Based Approach provides the Valuer with the cost of duplicating or replacing the assets of the company and is based on the assumption that a prudent investor would pay no more for an asset than its replacement cost. The Asset-Based Approach can be a reliable method for valuing tangible assets; however, the Asset-Based Approach may not recognise the full earning power of the total business enterprise.
The income approach estimates the value of a business based on the anticipated risk and return inherent in the investment. When a buyer purchases a business, what is being bought is a stream of prospective economic income. Economic income can be defined as any cash flow or benefit accruing to a business enterprise in exchange for goods, services or capital. The forecasted economic benefit or cash flow is capitalised or discounted at an appropriate rate to determine the estimates value of the business. Time in business, asset utilisation, operating results and customer and supplier relationships all influence the amount of risk relative to a particular entity. Anticipated benefits are then converted to a value taking into consideration the expected growth, timing of benefits, risk profile and the time value of money. In determining the appropriate discount or capitalisation rates, business valuers should consider factors such as prevailing interest rates, expected rates of return required by investors on comparable investments and the specific risk characteristics of the subject business.
The use of comparable sales of similar sold businesses as a guide to business valuation is one of the most important techniques for valuing businesses. The purpose of the Market Approach is to compare the subject business with the sales of similar businesses to estimate the value of the subject business relative to its peers. The timing of the sale, size of the comparable business, industry and the structure of the transaction must be analysed and compared with the subject businesses financial data. The market approach emphasises the principle of substitution, which assumes that an investor would gravitate toward the business with the lowest price if all other financial fundamentals and risks were the same.
The various methods of valuation that the valuers use in practice are typically considered as subdivisions of these broad approaches. Valuation methods under the Market and Income approaches generally contain common characteristics such as measures of benefit streams, discount rates and/or capitalisation rates and multiples.
The term ‘Valuation Standards’ refers to the various classes that a business valuation can adhere to. The various standards may produce very different answers for the same business so the valuer needs to establish the appropriate standard for the specific engagement. Sometimes standards may be nominated or mandated, other times it may be a function of the wishes of the parties involved. The following is a brief description of the valuation standards.
1. Fair Market Value
Of all the standards, Fair Market Value is by far the most commonly used standard of value. Fair Market Value is the estimated amount that a business will sell for between a willing buyer and a willing seller on the given date on the open market. Fair Market Value also assumes that both parties involved hold a reasonable level of knowledge regarding the relevant facts. The valuer is also required to make a number of assumptions as to the buyers/sellers behaviour and to the terms and conditions associated with the hypothetical transaction. Essentially, Fair Market Value does not take into account the individual circumstances of the buyer and the seller.
2. Fair Value
The primary difference between Fair Market Value, and Fair Value is that Fair Value relies very heavily on individual circumstances. For Fair Value to be established, both the seller and the buyer must have already been identified, and as such, the resultant value represents a figure beneficial and fair to both parties. Essentially it takes into account what the seller gives up in value and what the buyer acquires in value through the transaction. Being that this type of Valuation is a closed market value, the various influences introduced by an open market sale (financial, legal, operational, personnel, ownership, cultural etc) are eliminated.
3. Book Value
Refers to the depreciated market value of the fixed assets. These may include premises, plant and equipment, vehicles etc. This standard of Valuation is considerably less common than Fair Market Value and Fair Value as it doesn’t take into account intangible assets.
4. Asset Based Value
Though disregarding intangible assets in a similar fashion to Book Value, Asset Based Value ignores the book value and assigns value according to the potential resale of the physical assets in an orderly fashion.
5. Liquidation Value
Liquidation value is assigned to businesses that are no longer a going-concern. Value is established by the value of the terminated business, with focus on the value of its fixed assets, net of its liabilities and the inevitable costs generated by discontinuing operations. Though assets can be sold off in an orderly fashion, being that the context is liquidation; the haste of which assets can be sold off is generally taken into account.
6. Firesale Value
The price at which assets can be sold in the shortest possible time, regardless of how low the obtained price is.
7. Investment Value
Investment Value is comparable to Fair Value in that it is involved in Valuations for a Closed Market Sale. It is specific to an instance where the incorporation of the sellers company into the buyers company represents perceived synergies.
The following Valuation Services are provided for most industry types and business sectors.
- Limited Scope Business Valuation
- Full Comprehensive Valuation
- Valuation of Current date or Retrospective Valuation
- Expert Opinion if making a purchase of a business
All our reports comply with the:
- Accounting and Professional and Ethical Standards No. 225
- Australian Institute of Business Brokers Code of Conduct applying to Registered Business Valuers.