RESULTS DEPEND ON ASSUMPTIONS
The value of a business can varies because there’s no single way to determine the worth of a business. An investor may see the value of the business by only its past income and potential for future income, while another business owner may see value in the business through the goods or services it provides to the community. Furthermore, the economy can influence how you view the worth of the business. For example, a bad job market may drive up the selling price because there’s more competition in the marketplace.

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How a business is sold can also affect its value too. If it’s sold through a quick sale of assets at an auction (that is, in a “fire sale”), the value of the company can drop to cents on the dollar. Some businesses are worth more than the sum of its parts; some are worth less. If a business is sold on the open market after an intensive marketing effort to attract potential buyers, it can actually sell for more than its valuation.

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SELLING PRICE AND BUSINESS WORTH
Business worth is the price the business is expected to sell for. The actual price can vary depending on who does the business appraisal and other factors. For example, if you want to purchase the business immediately because it fulfills certain lifestyle goals, you may be willing to pay more than someone who wants a revenue stream at the most affordable price.

 

There are three basic ways to determine the value of a business. Each has advantages and disadvantages:
1.    Market Approach
2.    Asset Approach
3.    Income Approach

 

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MARKET APPROACH
The market approach relies on indicators from the marketplace to determine the worth of the business. The economic principle of competition applies, so the business appraiser asks what similar businesses are worth and uses that knowledge to establish a price. Just like appraising a home, our business valuation expert looks for comparable sales or valuations.

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If you want to buy a business, decide what kind of business you want and then research the going rate for similar businesses in your area. If you wish to sell a business, research the marketplace to see what businesses like yours are selling for. In either case, research market data to support your asking price or offer.

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The market approach determines a business’s fair market value. The fair market value refers to the price buyers are comfortable paying — and one that sellers also find acceptable. In a fair market agreement, the buyer and seller aren’t acting under compulsion and are aware of all the relevant facts.

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ASSET APPROACH
The asset approach for valuating a business counts all the assets and liabilities to determine the value of the business. Based on the economic principle of substitution, the asset approach estimates what it would cost to create another business similar to the first to produce the same revenue. This process involves setting a standard of measurement and using that to determine asset and liability worth.

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Every business has liabilities and assets, so it’s natural to look at them when trying to determine the value of the business. The difference between assets and liabilities is the value of the business. The challenge in using the asset approach is figuring out which assets and liabilities to examine in the process.

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INCOME APPROACH
The income approach of business valuation examines the primary reason for going into business — to make a profit. This business appraisal uses the economic principle of expectation. The income approach weighs the revenue and benefits that the buyer receives against the time, money and effort that they need to invest into it.

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The risk in the income approach is that it attempts to measure future profit. Since there’s no money in the bank yet, you can’t be sure when or if you’ll receive revenue from the business. Business evaluation services provide current value, not future value, so you may be buying or selling based on expected income that has to be translated to today’s marketplace.

 

The income approach makes this translation through discounting and capitalization. Discounting projects revenue streams over a period of years. Capitalization divides the expected revenue by the capitalization rate. For example, a business is worth three times its annual revenue if the capitalization rate is 33 percent.

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Next, you estimate the value of the business at the projection period’s end. This is known as the terminal or residual business value. The discounting calculation provides you with the present value of the business.

DIFFERENT RESULTS FROM DIFFERENT VALUATIONS
It’s possible and even likely to arrive at different business appraisals with the different methods. Since your perception of risk may differ from other buyer’s or seller’s, you may arrive at a different value. You also may have different goals and plans for the business, which affects your revenue projections.

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Even if you’re using the same methods as others, you can end up with different values. Determine which approach may best serve your needs with advice from our business evaluations services experts.