7 Things to Know About a Accurate & Defensible Business Valuation
In this article we will be exploring two absolute must-know elements of business valuations and five tips to help you obtain the valuation you need. Accuracy and defensibility are paramount, but how can you find the key factors that will lead you toward an accurate and defensible valuation? How can you be sure that you’re ready to get started with the right valuation professional and if they can provide everything they promise?
We have answers here so you can know how to identify capable and experienced valuation experts. Then, we consider the vital information that can prepare you for the process of reviewing and valuing your business.
Must-Know Elements of an Accurate and Defensible Business Valuation
Valuations are never cut-and-dry. They dive deep into areas of the business that don’t appear on financial reports, IRS forms, or insurance agreements. A valuation must cover everything on and off-paper and then account for the potential setbacks or advancements. It’s a mixture of art and science solidified through a balance of experience and expertise. If a valuation expert is missing any part of this formula, they aren’t prepared to handle a complete valuation.
The science of business is quite complicated. The mathematics and reasoning behind a valuation include:
- Consideration of the market forces
- Interest rates
- Analysis and calculation of appropriate discounts for risks to yield the correct capitalization rates
- Fluctuations of equipment and inventory
- Industry shifts
- Demand for acquisition of businesses
- Changes within the economy
The valuation expert can assess all the prices previously indicated, however, applying those assessments to the valuation of the business also requires finesse and proper judgment. Everything here begins with looking at hard numbers, variations, and facts. Then, we move into the world of projections, quantifying areas of business that are complicated to quantify.
Assessing the value of the intellectual property, the labor force, and management experience is more art than anything else. What value can you assign to a business owner who has led many successful campaigns, helped grow the company, and is a reliable leader? That is the art part of business valuation services. Many factors go into assigning value to elements that often feel beyond value.
A business valuation expert can have years of experience but still not have the expertise to fit a particular project. Expertise requires knowledge, skill, and experience. An appraiser may have expertise in business real estate appraisals, but for a defensible and accurate valuation, you need a well-rounded business valuation expert.
Although degrees and certifications can help support the abilities of a valuation expert, experience is the only real proof. Has the expert provided accurate and defensible valuations in the past? Is there experience within your industry? Does this person have years in handling valuations? You can use these questions to determine if this person has sufficient experience relative to your business.
Know Your Reason for Acquiring a Business Valuation
Valuations happen for different reasons, and the cause of the valuation can help the business owner understand what they will need and what they should expect during the process. The purpose of the valuation can include the need to sell the business, assess assets for divorce, to finance debt or equity, address cash flow issues, and even for handling taxes.
The valuation will determine the scope of the analysis and the type of valuation report needed. It is always important to have an accurate and defensible valuation. It is equally important for the valuation expert to understand how you intend to use the valuation report and what scrutiny or questioning it might face.
Evaluation for selling the business will need to withstand vicious negotiations to lower terms for sale. Alternatively, a valuation for tax purposes will need to have a solid foundation to support its tax information, revenue, and tangible asset valuations. It is essential for business owners to understand why they are pursuing a business valuation, and they must convey that to the valuation professional.
5 Tips for Obtaining an Accurate and Defensible Valuation Report
We’ve already covered the two most important factors for obtaining a business valuation, and here are five tips that can help ensure you get an accurate and defensible valuation report. These elements play into a high-quality business valuation, but they don’t come with every valuation service. In some cases, a business valuation professional may simply use documents that you provide, or they may investigate and do some forensic financial work on their own.
Understanding these factors can help you prepare for the valuation process. As you prepare yourself, it can help you find the best possible valuation expert for your circumstances.
1. Prepare your financials
Your most up-to-date tax returns will play a substantial role in the accuracy of the business valuation. In addition to your tax returns, you’ll need accurate and transparent profit and loss statements as well as balance sheets. If you regularly have your business audited by a CPA firm, that information will help the valuation.
Business valuations always start with hard financial data. Valuation experts want to assess the value of tangible assets and the company’s current financial health. An evaluation expert may need the past three years of financial documents to create a truly accurate representation of your company’s financial situation.
2. Assess and forecast revenue
One of the more artistic elements of a business valuation is the consideration of future success. A forecast of revenue and profitability is extremely valuable when selling a business.
Most valuation methods consider:
- Balance Sheets
- Earnings before interest, taxes, depreciation, and amortization (EBITDA)
- Financial projections
They use those concrete financial factors to help create a five-year growth forecast. Of course, other elements such as changes in the industry, intellectual property, and even your management team can impact the revenue forecast.
Determining the future outlook of the business is not easy, and it opens the possibility of someone questioning the valuation. Any investor or purchaser will specifically focus on future outlook, so it’s important that the forecast for revenue accurately represents what the company can accomplish. To increase defense ability, they may evaluate the company compared to competitors in the industry and evaluate factors that impact prospects. Other factors can include client and vendor agreements, contractual obligations, and management plans.
3. Hire a professional
The surefire way to ensure that your valuation is both defensible and accurate is to work with a professional with years of experience and expertise. Ideally, you want a business valuation expert who handles these projects on a full-time basis. There are many credentials, accreditations, or certifications that indicate a professional can provide a defensible valuation.
Education and certifications are only some factors that you should consider when hiring a business valuation expert. Expertise and experience are crucial elements. Always shop around and obtain estimates from a few different valuation experts. Then you can compare their quotes and their experience, certifications, knowledge set, and understanding of your circumstances.
4. Know your CapEX
Your capital expenditures can significantly impact your valuation. Capital expenditures include cash or credit payments towards long-term assets that maintain or improve a business’s operations. These expenditures are not directly reflected on a company’s income statement or the balance sheet. Instead, they reflect an investment by the company into expanding or improving the business.
Many business owners overlook capital expenditures when conducting business valuations because they don’t show up on typical financial documents. When developing a business valuation, you want to review and calculate your CapEx into the future. CapEx will impact your cash flow, and that can significantly affect your valuation.
Review and calculate what your capital expenditures will look like in the future to help support the current valuation.
5. Complete the Valuation Questionnaire
The American fortune valuation questionnaire helps to obtain a wider scope of your business. We immediately address factors that many business owners don’t consider when conducting their valuations. How long have you been in business, and what percentage are the top three customers representing your total revenue?
Some factors on the questionnaire that can impact the accuracy or defense ability of evaluation are elements that seem like day-to-day matters. Questions such as, “is the company dependent on its current owner?” can deter or incite potential buyers. Meanwhile, the projected year-end revenue listed in the valuation might indicate factors to consider if the valuation is for litigation purposes.
The American fortune team looks to create accurate and defensible valuations that fit our client’s unique needs. Valuations always begin similarly, but they quickly develop into a one-of-a-kind project with the combination of art, expertise, and experience. Contact our team and explore the process of working with experienced business valuation experts