Business valuations aren’t driven by bricks and mortar sitting on a piece of land. They’re driven by the reason someone wants to acquire a business or get rid of one. An asset’s value is ultimately driven by the rationale for a transaction. The best valuation reports tell a story about the history of a business, its pros and cons, and most importantly, its potential. Understanding what a finished product should look like is always helpful before you start a process, so this post also lays out the general elements of any business valuation report that you’d pay for from a business valuation consultant or appraiser. Reports can vary in length and complexity based on the complexity of the job. Here, we give you a very basic starting point so you can see how reports present the essential information of valuation.
In this post, I discuss the basic elements of a business valuation report, with the understanding that no two reports, like no two business valuations, should ever be the same.
Note: This post is focused on working with a valuation professional in determining what a business is worth. But in watching the habits of appraisers, accountants, and estate and tax attorneys, you should be gaining insight, too. So as you read, put yourself in the shoes of a trained valuation professional each step of the way — you’ll start to figure out which facts to focus on and which questions to ask.
What a Valuation Report Is Supposed to Do
A good valuation report, like any piece of quality research, should open your mind to possibilities you’ve already considered and maybe a few you haven’t thought about. As we mention throughout this post, putting dollar signs in your eyes isn’t the job of a quality valuation professional. Nor is it her job to search in every corner for value or for data, events, or hidden matters that may take value away.
A good appraiser’s job is to provide a third-party, objective opinion on what would actually happen if the subject company were for sale on the open market. You get a median valuation as the result, but if the appraiser or valuation professional is doing her job, you get what’s known as a range of values, a compilation of opinions based on various methods of valuing those assets.
Always ask valuation professionals how many different methods they may potentially use to value your particular business and how they’ll communicate those results to you.
A valuation report may contain very good news for you and your company or for the company you’re hoping to buy. Or it may contain some bad news that sends you back to the drawing board but prevents you from making some expensive mistakes in the end.
Major Mistakes That Show Up On Valuation Reports
Understanding potentially big gaps in a valuation report is important — after all, you’re paying for it. Such problems may include the following:
- Failing to state the date of the valuation and the date the report was prepared; both may be critical in a court proceeding
- Leaving off — or failing to consider — the purpose of the valuation
- Not listing the standard of value for the valuation (fair market and so on)
- Never doing a proper site visit
- Not detailing proper assumptions about the business and the purpose of its valuation at
- Not detailing the industry and the marketplace trends the company will be affected
by, as well as its current and future economic prospects
- Not reviewing all valuation methods necessary for this particular situation
- Not defining the kind of earnings used in computation, if using the income approach
- Not going far enough with guideline company data, if using the market approach for
- Failing to apply the proper discount or capitalization rates necessary for the valuation
- Failing to disclose all sources of data used for comparison
Typical Valuation Report Outlined
Every valuation professional may have a particular style, but most valuation reports follow a certain structure. I cover each section of the report in greater detail in the following subsections. For now, though, take a quick look at the setup:
- Valuation summary (including assumptions and limiting conditions)
- Table of contents
- Executive summary
- Valuation summary
- Valuation assignment
- Economic outlook
- Industry outlook
- Business overview (including cost of capital, discounts, and premiums)
- Conclusion of value
- Appendixes (charts, footnotes, glossaries, and more)
A valuation report has no set number of pages. The length depends on the complexity of the assignment and the valuation possibilities based on the valuation goals being sought.
A cover’s a cover, right? Well, in addition to looking at all the key information about the valuation firm, its contact information and where it’s located, and its cool logo, you need to check one piece of key information and make sure you understand it: the date. Know whether the printed date is simply the date when the report was turned over to you or whether it reflects the official date of the valuation.
You need to be very clear about all the critical dates in any valuation you commission. The valuation date is critical because if this report is being done for tax reasons or eventually becomes evidence in a lawsuit or divorce action, the time sensitivity of the analysis becomes all the more important, depending on the circumstances of the case.
Depending on what your plans are, when you do the valuation is a critical step in the process. Valuation isn’t just about the dollar sign at the end of the transaction — it’s also about timing.
Unlike mystery novels, you don’t have to flip to the end of most valuation reports to figure out what happens. You can pretty much flip past the cover and the table of contents, and then, boom — you find the number you’ve been waiting for. It looks something like this:
The fair market value of XYZ Co. is $1.2 million based on a weighting of income and market valuation methods.
Note the phrase “weighting of income and market valuation methods”. This particular company was valued based on the income approach and market-based comparisons. This fact may not be true for every business, which is why you need to do your homework about what kind of valuation approaches and methods best fit a business in your situation. Talk over these choices with a valuation specialist.
Your report will probably also indicate a high/low range for the value of the business, based on various valuation approaches and control premiums and special situations (including minority ownership, if it applies in your case).
The rest of this section of the report usually delivers the following kinds of information.
The Assumptions And Limiting Conditions Of The Business
This section is a statement of assumptions and conditions on which an appraisal is based that the appraiser may or may not have verified.
A standard valuation may contain a statement that describes items such as the following:
- That the title and legal description of the business are correct
- That the property is free and clear of liens
- That the current management and ownership have been verified and declared responsible for the business
- That the factual information received from others in the course of creating the report is reliable
- Notes on the illustrative material
- Any environmental impact statements that may be relevant
- That all licenses necessary to operate the property have been obtained
- That there is evident compliance with zoning and land use regulation
Everyone likes summaries. The executive summary enables you to see the critical points in the valuation process.
Purpose Of The Valuation/Ownership Structure
This section tells you the assumption of ownership upon which you’re basing the valuation. If this business is a target company and you want to own 100 percent of it, that situation requires certain assumptions and valuation methods of its own. Of course, if you’re valuing a portion of the ownership instead of 100 percent (if you’ll have a business partner or two, or if you’ll own jointly with a spouse or other family members, for instance), you’ll see more details on what discounts or premiums have been added to the computations to affect that total valuation.
In the business valuation context, discounts or premiums are facts that either enhance or diminish the salability of a business and, therefore, the amount of value.
Standard Of Value
The standard-of-value section can be combined with one of the opening sections. Regardless, you need a statement of the standard of value used to create the valuation. Fair market value, fair value, strategic value, and intrinsic value all result in different value conclusions based on the type of company being considered.
The subject of valuation and standard of value also helps determine whether you need to take various discounts, including discounts for lack of control and lack of marketability, as in the case of valuing minority interests in a company.
If you’ve had your business valued in recent years, keep in mind that the same standard of value and methods may not apply based on your goals for this valuation. In other words, let the goals and the current structure of the company govern which methods to use to complete the valuation. Don’t make decisions based on decisions you made before.
The Valuation Date
This section covers the particular date the valuation was done. All valuations must be set on a particular date to allow the valuation professional to freeze a company’s conditions and financials at a moment in time.
Describing the assignment after seeing the numbers may seem a little backward, but admit it — you wanted to see that dollar figure first, right? This section of the report talks more about the features of the company itself.
The Valuation Key Assumption
In a report that aims for clarity, you see something here called the valuation key assumptions. Granted, you may want to value a business because you’re thinking of selling, but valuation professionals think a little differently. They look at all the assets you have and make an assumption based on what they think is the best way to monetize those assets. The valuation professional may state here that the sum total of assets would be best sold as a whole —as in a sale of the company outright — or may state that the assets would attract more cash if sold separately.
The Assigned Valuation Date
I start this post by discussing how important the valuation date is. Who sets the date? Optimally, you or your representative does. Competent valuation professionals don’t set the date because it’s not their job to decide the critical facts of the valuation, and the valuation date may be among the most critical. Timing issues should be the purview of buyers and sellers, not people who value companies.
In other words, companies that are planning to go on the block immediately may want the most recent numbers for the company figured into their valuation picture, particularly if those numbers are perceived to enhance the value of what they’re selling. Companies that want to obtain bank financing or equity participation in their business may want to set different timelines.
If a valuation professional offers to help you set the valuation date, be wary. Qualified valuation professionals typically insist on a written recommendation from the client or the client’s attorney specifying the exact valuation date. That way, they never have to redo the assignment; if the date is wrong or changes for any reason, the client or the client’s attorney then must start the process all over again.
Dates can be a critical factor in the valuation process. Divorce, estate, and gifting issues are examples in which valuation dates certainly matter. As for the ordinary buying and selling of companies, the date doesn’t matter as much, but a date must be set at some point. For example, the initial valuation of a company may be based on the last full year of financials for analysis in a report, but eventually, the year-to-date performance of a company will have to be communicated to be part of the report or not. A smart buyer or a banker considers any data more than 90 days old to be outdated.
Don’t hire any valuation professional who doesn’t watch how world and domestic economic factors affect your industry. Anyone can watch business channels and read as much as possible about the general state of the economy, but a business valuation professional has to know how to apply that macro view to the micro world of your business.
Today the most successful companies — even ones that are tiny right now — are global, thanks to the reach of the Internet and what it enables even the smallest companies to do. Even the smallest manufacturer can develop a supply chain that reaches all the way to Central Asia or the Far East. A small consultancy can have clients halfway around the world.
When various segments of the world economy experience either good times or downturns, valuation professionals can’t turn a blind eye to those trends. They must pay full attention to anyone a company is doing business with or competing against.
In a business valuation report, you should see detailed notes on how the economy is playing out, both in general and in particular in your sector of business. You’ll probably see economic terms such as the following:
- GDP: The gross domestic product is the value of all the goods and services produced within a given year. The GDP is a crucial way of measuring how free businesspeople feel to invest in their businesses and increase production.
- Interest rates: People watch the Federal Reserve Board closely for a reason: It sets the general course of what borrowers will pay at all levels of the economy. Banks, businesses, and ordinary individuals find it easier to borrow and increase their spending when credit is looser; when credit is tighter, they slow down. Valuation professionals should bring this trend down to the level of the client who has to borrow in a particular economic climate.
- Commodity prices and exchange rates: If a business works with particular raw materials, such as metals, foodstuffs, or energy products, it needs to know how costs for those particular items will affect the cost of production in the business’s area. Likewise, exchange rates — a reflection of the value of world currencies — can have a detrimental or a positive effect on a company’s operations overseas. Valuation professionals need to know where these trends are heading and whether those measurements will increase or decrease valuations over a stated term.
- What Washington plans to do: Political and policy considerations are also important drivers of the economy. What the president and the nation’s legislators hope to do with regulatory, tax, and energy policy is crucial to business. Again, valuation professionals need to know how federal legislation will affect state legislation that deals specifically with the business in question.
- Key measurements: Depending on the size of your business and its industry, you probably follow a market indicator that measures how your sector of the economy is doing. These indicators may include the following: (1) The NFIB Small Business Economic Trends report: The National Federation of Independent Business produces a series of research reports that describe how small companies feel about their businesses right now; (2) Industry-specific indexes: Pick an industry, and you’ll find an index. Many trade publications have developed their own economic indexes to measure economic activity. Equally important, a valuation professional must understand how your competitors are doing. If you don’t get the sense that a valuation professional is asking enough annoying questions about who your competitors are, how they’re doing, and whether they’re gaining on you, he’s not working to learn enough about your business.
- The state of capital spending: Capital spending is a driver of economic growth. You want to see whether companies anticipate spending more to make investments in their business. Even more important is seeing where they’re going to make those investments.
- The state of business financing in general: Most businesses need to have some relationship with credit. Sources of credit are always tight. In preparing to buy or sell a business, a valuation professional needs to keep the overall credit environment in mind.
Business valuation professionals are supposed to shine the cold searchlight of truth on the state of the subject company’s industry. To value a company properly, it’s important to know what the leaders in the industry are doing, what their products are, and what their growth prospects are. Valuation professionals use news stories, database material, and a host of public and private company data to create this story.
As with the rest of the valuation assignment, the industry story isn’t told in a snapshot view of what’s going on during the latest year of business. You should see comparisons of revenue and operating profit growth for the industry over a certain period or whatever is appropriate in the context of that industry so you can get an idea of possible three- to five-year prospects going forward.
Other factors you see in the industry outlook section of the report include the following:
- Growth prospects – The valuation professional’s job is to give you an opinion on where your company stands on that growth path, but doing due diligence on that front is your job as well. If you’re a thoughtful participant — or potential participant — in an industry, you owe it to yourself to know something about that industry’s growth prospects and where the business in question ranks. Otherwise, how can you really trust the information other experts are providing you?
- Potential threats and benefits for the overall industry – If the company being valued is a manufacturing company in a particular industry, such as computers or toys, you’ll likely see a comparison made to the overall growth of manufacturing businesses in the United States (or internationally as well, if that’s a necessary point of comparison). Some valuation firms develop their own proprietary systems and formulas to further analyze this issue; others simply report what they’re seeing in the news and from other trade sources that closely follow the industries. One is not necessarily better than the other.
You may know the business you’re in, but you want to see how the valuation professional describes what you do. You want to know how much they know about you. This section explains the parts of the report’s business overview.
The median value is just a convenient midpoint; it doesn’t represent the revenue multiple for any actual transaction. It indicates that half of the revenue multiples are below the median value and half are above. Median values depend on the attributes of the firm and the outside data points an expert uses to value it.
Your overall financial performance – The overall-financial-performance section usually consists of a one-year summary of your target company’s financials, but the report also makes many references to the company’s financials over a multiyear period. It may be accompanied by a chart of three to seven years of the company’s financial performance. Using outside professionals can be invaluable in discovering what your business is worth, but try to identify and make friends with people who own businesses similar to yours who aren’t competing directly with your company. Buy them a meal or coffee and talk to them about what they hear similar businesses are going for in your area. If you don’t feel you can just call someone up (you really should get over this fear, by the way), try joining a chamber of commerce or an industry association that serves your type of business. If nothing else, you’ll get to know your competition even better.
How financials were adjusted/normalized (and for what purpose) – Valuation professionals adjust financial figures to accomplish certain goals or to facilitate certain valuation methods. These adjustments may be for one-time nonrecurring expenses such as a rare lawsuit or maybe capital expenditures from a flood or fire. The adjustments are typically derived from control adjustments. Put in simpler terms, one of the tax advantages of owning a privately held business is the ability to run certain expenses “through the business.” Owners may have family members on the payroll who aren’t essential to the operating of the business. Or they may be burying certain personal items that aren’t essential to day-to-day business operations. Examples include the following:
- Cars and car insurance (also boats, airplanes, and vacation homes)
- Personal travel and entertainment
- Country club dues
- Healthcare for family members
When maximizing deductions for tax purposes, these control adjustments are common. As long as taxpayers are using them properly under the U.S. tax code, all should be well. But potential sellers should be prepared to open up their books because, many times, these control adjustments are major factors in getting to the cash flow used for the income approach. If people are playing fast and loose with how they’re preparing their taxes because they’re being overly aggressive with running personal items through the business, they probably need to take a year or two to clean up the financial statements before a sale or valuation.
Assuming that this company is a small business with a single owner, the owner’s-compensation section is where you see the company’s top salary benchmarked against that of executives at similarly sized companies in the same field. If this salary is above the range, it may be valued outside the expense side of the company’s normalized financials: If the business changes hands, a new chief executive walking in the door may not need to be paid as much. In larger firms with more top officers, you may see a broader benchmarking of salary data.
And what happens if a business owner isn’t paying herself a fair market wage for the size of her company or business? That in itself may indicate poor stewardship of the company you may be planning to buy. And that’s another important reason to analyze compensation.
Conclusion Of Value
The scope and depth of the valuation assignment determine how many valuation methods the professional employs in the valuation of the company. The report’s conclusion-of-value section devotes space to why each method was used and what computations were used to establish the standard of value.
You should see a narrative description of each method, along with a chart of the computations used in each method.
Methods Examined And Accepted/Rejected
This section discusses the approaches and methods considered and rejected (and reasons why), as well as the approaches and methods considered and accepted to provide a reasonable conclusion of value.
Explanation Of Weighting Each Valuation Method
Weighting is an indicator of importance — a ranking. Some valuation methods weight certain methods to reach a conclusion of value. Other reports do not. That decision depends on the school of thought or philosophy of the individual appraiser.
The next stop may be discounts and premiums. That depends on the scope, depth, and purpose of the assignment — and may also depend on the appraiser’s philosophy. In some instances, the discount and premiums are calculated within the method. And in some cases, they’re applied after determining the overall value. If they appear after the conclusion of value, the professional sets numbers for the following:
The firm’s control premium: This premium represents what an interested suitor — or existing shareholder — would pay to get majority control of a firm.
The firm’s marketability discount: This discount, a factor that actually decreases the value of a company, is tied to various factors that make a business tougher to sell. Marketability discount is a natural issue for private companies because their shares do not trade on public markets and their value isn’t set publicly on a daily basis. Experts can apply various methods to come up with the discount that must be applied, including the restricted stock method, the IPO method, and the option pricing method.
You may also hear about the liquidity premium — it’s an extra reward that investors demand for tying up money in the firm for a longer period of time than they may otherwise choose.
Accounting10 years ago
Check Payment Issues Letter [Email] Templates
Accounting10 years ago
What is Journal Entry For Foreign Currency Transactions
Accounting6 years ago
Accounting for Business Acquisition Using Purchase Method
Accounting10 years ago
How To Calculate And Record Depreciation [of Fixed Asset]