One of the key assumptions made for any business appraisal is the premise of value. Depending on the circumstances surrounding business valuation the results may differ greatly.
By far the most common assumption for valuing a business is that it will continue operating in the foreseeable future as a going concern.
However, there are situations when other premises of value apply. When a valuable asset is bought, the owner is likely to ensure it. Insurances companies are concerned with total loss of the asset. The insurable value is thus the cost of reproducing the lost asset.
On the other hand, a lender that considers the business asset as a collateral is more likely to value it on the liquidation basis. The worst case scenario for the lender is the possibility of having to dispose of the asset at an auction. The price fetched in these circumstances is likely to be considerably lower than the fair market value. In addition, the lender incurs additional costs associated with the sale.
Small wonder that the replacement cost value and liquidation value are usually far apart. This makes sense because the circumstances of valuing the business asset are so different here.
If a business asset is lost in needs to be replaced. So the cost of acquiring a new asset dictates its value. On the other hand, a lender is probably not interested in using the business asset nor in incurring the maintenance and marketing costs to get the highest price possible. A forced sale under the auctioneer’s hammer is likely to fetch a lower price.
On a value continuum, the replacement cost and liquidation values are at the opposite ends of the value range. Somewhere in the middle is the fair market value that indicates what the business asset is worth in use. In business appraisals, this value is determined as the replacement cost less the depreciation due to use, aging and obsolescence.
Before you can apply business valuation methods, you should determine the level of cash flows generated by the company. The question here is what cash flow?
For the purposes of business appraisal, the net cash flow is the typical choice. Here is its definition:
- Net income, after tax
- Plus depreciation and amortization
- Plus tax affected interest expense
- Minus capital expenditures
- Minus increases in working capital
Note that the net cash flow represents the cash that is seen by the shareholders and long-term interest bearing debt holders of the firm. In other words, it is the earnings that defines the value of all equity and debt interests in the company.
A couple of comments are in order here. First, net cash flow is an after tax concept. The reason we start with the after tax income is to focus on the earnings regardless of the company’s capital structure, i.e. what levels of equity and debt capital it uses.
To do so, the net cash flow is adjusted for the tax effect, as you can see in the above list.
Secondly, adjustments done for purely accounting purposes need to be added back. The typical ones are the paper expenses such as depreciation and amortization.
Finally, the funds needed to keep the company going need to be factored out. This includes both the long term capital expenditures and the working capital requirements. These funds cannot be taken out of the business and distributed to owners or lenders. The money is needed to buy new equipment, inventory, and other valuable assets the business needs to operate.
Net cash flow represents the level of business earnings most relevant to business appraisal. It shows the cash flow the owners can direct at their discretion toward business expansion or distribution to the shareholders. The effect of capital structure is removed since the owners can decide what levels of equity or debt they want to use in their business.
Business Valuation Based on Net Cash Flow
The ValuAdder team has completed yet another major milestone in product design. The new ValuAdder 8 comes with all the tools and features business people and professional valuation experts would want in a modern business valuation system.
All new reporting system based on Open Source Scala software technology
A major addition to ValuAdder 8 is the all new reporting system. Using the leading edge Scala software development technology, ValuAdder engineers have created a truly powerful reporting engine. Each business valuation method and financial analysis tool in ValuAdder features a dedicated report. You can create a report with a mouse click as you do any calculation.
The report you produce has a clean, professional look, crisp design and high quality fonts. Data tables are laid out to enhance presentation.
Each report includes a helpful explanation of what the reported calculation is about and what each item means.
You can share your business valuation results in a number of ways: print it in any format you like, create an electronic copy in the PDF format or email the report for review by colleagues or clients.
All valuation multiples, discount and capitalization rates updated
In addition, there are critical updates you will find essential. All the parameters that make your business appraisal timely and relevant have been updated to match the current market conditions.
All ValuAdder software products, whether intended for a PC or Mac computer, are digitally signed to ensure security and integrity of your computers. This is especially important if you choose to download your software for immediate installation. The digital signature is verified prior to installing software by your Windows or Mac computer. This is your assurance that you get a product that is free of malware threats and performs as you expect.
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