An economic analysis, or professional engagement, to conduct business valuation in order to determine the worth of a business, professional practice or certain business assets.
What It Means
A business appraisal is called for when the business is to be sold, business ownership interest is gifted or transferred as part of an estate, addition or departure of business partners, legal separation of business owners, or for business financing purposes.
Typical business appraisal recipients are business owners and buyers, commercial lenders, investors, tax authorities, legal professionals and courts.
The assumptions you make when estimating business value make a big difference to your business appraisal results. Before undertaking a business appraisal, you need to address these key questions:
- For whom is the business value determined?
- What are the circumstances of business appraisal?
Business appraisal assumptions: standard and premise of value
To specify the assumptions at the outset, business appraisers talk about the business value standard and premise of value. Once these are understood, you can make a choice of the business valuation approaches to use – the fundamental ways a business worth can be determined.
Ways to appraise a business
There are three ways, known as the business valuation approaches, to estimate the value of any business:
- Market approach
- Income approach
- Asset approach
Business appraisal techniques
Under each approach to valuing a business, you can choose a number of methods to do your business appraisal. While the methods under each business valuation approach share common traits, the actual business valuation formulas used are different. It is a good idea to use several business valuation methods to calculate what your business is worth.
Choice of a business valuation model
In fact, the set of assumptions and selection of business valuation methods you make at the outset represent a distinct business valuation model. The model depends upon your business appraisal needs.
For example, if you are calculating the value of a start-up, valuation multiples derived from established company sales are not very useful. Income business appraisal methods, such as the Discounted Cash Flow, are a far better choice.
On the other hand, if you are appraising the value of an established company, business goodwill valuation may be a key requirement. In this case, your business valuation model should include the Capitalized Excess Earnings valuation method that lets you calculate the value of business goodwill.
Reporting a business appraisal
No business appraisal is complete without a well-written business appraisal report. This important work product details the assumptions made, outlines the essential elements considered in business appraisal, indicates the choices of business valuation methods and the results of their use in determining what the business is worth.
Business appraisal standards
A well done business appraisal must be clear, easy to understand and defensible. If you are to share your business valuation results with others, compliance with key business appraisal standards helps to establish credibility. Important business valuation standards in common use include USPAP, AICPA SSVS, and IVS.