The Importance of Business Valuation
For some companies, having an educated and informed understanding of what their business is worth economically may not be on the shortlist of things to accomplish. The problem might signal a lack of awareness about the importance of business valuation. For some companies, not having a business valuation done may simply be an oversight.
After all, there are so many ins and outs to keep up with when running a company, it is understandable to make some omissions along the way or put off “less urgent” tasks while putting out fires! However, a valuation uncovers critical information that serves a variety of purposes. Let’s dive in.
Why Business Valuation Is Important
Business valuation is exactly what it sounds like: it is the process of determining the true value of a business. In other words, it gives you an educated number, or price tag, if you will.
You may be wondering why business valuation is important if you are not selling your company. That is a great question.
This information goes beyond just preparing to sell your company; it is a good idea to know the value of your business in order to fully engage with your goals and objectives. For example, valuation can help you make well-informed financial decisions and develop more targeted marketing strategies.
The importance of business valuation should be considered for businesses at any stage of the game. A business valuation conducted by a professional can be used in many planning scenarios. Take for example the old saying “if I get hit by a bus tomorrow…” Business owners can have the best intentions in the world, but they are not immune to accidents that would suddenly render them unable to carry on with business as usual.
In the case of an unexpected death, a business valuation will be a necessary tool to ensure the heirs of the business are able to sell the business with expedience if necessary. In cases such as this, a business valuation ensures the heirs do not overpay in taxes after the sale.
The goal of business valuation is to establish the fair market value of your business. The estimate you arrive at after conducting a business valuation is one that can be substantiated later on should the need arise. There are often costs associated with a valuation, but that should not deter you as the importance of business valuation should be weighed heavily as you strive to keep your company healthy and stable.
A complete and comprehensive business valuation can cost as little as a few thousand dollars or in some cases as much as $50,000 or more. There are certain advantages that come along with working with a professional firm to find the value of your business on the open market. Chief among those advantages is the fact that the valuation of your business done by a contracted firm should be seen as objective and independent in the eyes of the IRS.
If you are still wondering why business valuation is important you may want to consider the idea that despite all of the best planning in the world, the need to sell a business can arise seemingly from nowhere. A savvy business owner is prepared for many possible scenarios and does not take anything for granted!
Fair market value can be defined as the price a business will be sold for. In this scenario, a sale will exist between an informed and willing buyer and an informed and willing seller. Neither the buyer nor the seller will be coerced into the sale and all parties will have knowledge of the important facts.
The importance of a business valuation can also be demonstrated when it comes to accounting. To understand this, we must understand book value. Book value is a simple formula: assets minus liability. The issue here is that property can be listed on a balance sheet as its original price minus devaluation. The problem with that, as well all know, is that devaluation doesn’t take into account resale value. Imagine you are selling a used car.
Do you simply take the purchase cost and subtract for depreciation? Or, do you factor in the make and model of the car and the current market for that car on the market? If you are not considering the latter, you will be selling your used vehicle for less than other sellers with an equivalent vehicle. That is why it is necessary to think about the cost of replacing property, say machinery for example, at current prices. This is a great example of exactly why business valuation is important. Simply taking the book value does not factor in all the essential calculations.
There are three main calculation options for businesses seeking valuation by independent assessors.
The first option is to take annual earnings over a year or more and divide those earnings by a cap rate. The cap rate reflects the capital and risk of the company. This method is called Capitalization of Earnings. The second option for businesses is to use Discounted Cash Flow. In this model, a business will calculate its worth by forecasting future earnings. The third method is to consider recent sales of comparable companies in the same industry. This method is known as Comparable Sales and Discounts.
Working with an experienced business valuation professional makes the process as streamlined and simple for you as possible. Contact AMB to learn more.