Why assumptions are essential to your business valuation

It is well known that all business valuations are done as of a certain date. It is possible to prepare a business appraisal at some point in the past. One benefit of this is that you have some ideas as to how things actually turned out.

In fact, professional business appraisals are sometimes done as of an earlier date. This may be a requirement in divorce or a merger and acquisition deal when the initial cost basis needs to be known.

Such cases aside, most business valuations you are likely to see are done as of the current date. Business valuation methods, especially those under the income approach, rely on a number of critical assumptions that affect business cash flow going forward. Among these are expectation of future revenues, operating expenses, competitive environment, regulatory compliance, interest rates and taxes, to name but a few.

In fact, you cannot use any income business valuation methods without outlining your assumptions. Both the earnings forecast and risk assessment, the two types of inputs these methods take, are forward looking and call for a leap of faith. In other words, all business appraisals require an educated guess about the future.

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