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Owners of private businesses often wonder: How much is my business interest worth? Financial statements are a logical starting point for answering this question. Here\u2019s an overview of how financial statements can serve as the basis for value under the cost, income and market approaches.<\/p>\n
Cost approach<\/strong><\/p>\n Because the balance sheet identifies a company\u2019s assets and liabilities, it can be a good place to start the valuation process, especially for companies that rely heavily on tangible assets (such as manufacturers and real estate holding companies). Under U.S. Generally Accepted Accounting Principles (GAAP), assets are recorded at the lower of cost or market value. So, adjustments may be needed to align an item\u2019s book value with its fair market value.<\/p>\n For example, receivables may need to be adjusted for bad debts. Inventory may include obsolete or unsalable items. And contingent liabilities \u2014 such as pending lawsuits, environmental obligations and warranties \u2014 also must be accounted for.<\/p>\n Some items may be specifically excluded from a GAAP balance sheet, such as internally developed patents, brands and goodwill. Value derived under the cost approach generally omits intangible value, so this estimate can serve as a useful \u201cfloor\u201d for a company\u2019s value. Appraisers typically use another technique to arrive at an appraisal that\u2019s inclusive of these intangibles.<\/p>\n Income approach<\/strong><\/p>\n The income statement and statement of cash flows can provide additional insight into a company\u2019s value (including its intangibles). Under the income approach, expected future cash flows are converted to present value to determine how much investors will pay for a business interest.<\/p>\n Reported earnings may need to be adjusted for a variety of items. Examples of items that may require adjustments include depreciation rates, market-rate rents and discretionary spending, such as below-market owners\u2019 compensation or nonessential travel expenses.<\/p>\n A key ingredient under the income approach is the discount rate used to convert future cash flows to their net present value. Discount rates vary depending on an investment\u2019s perceived risk in the marketplace. Financial statement footnotes can help evaluate a company\u2019s risks.<\/p>\n Market approach<\/strong><\/p>\n The market approach derives value primarily from information taken from a company\u2019s income statement and statement of cash flow. Here, pricing multiples (such as price to operating cash flow or price to net income) are calculated based on sales of comparable public stocks or private companies.<\/p>\n When looking for comparables, it\u2019s essential to filter deals using relevant criteria, such as industrial classification codes, size and location. Adjustments may be required to account for differences in financial performance and to arrive at a cash-equivalent value, if comparable transactions include noncash terms and future payouts, such as earnouts or installment payments.<\/p>\n Independence and experience count<\/strong><\/p>\n Business value is a critical metric, whether it\u2019s used for financial reporting, M&A, tax planning or litigation purposes. But never base a major decision on a do-it-yourself appraisal. Contact us for help calculating an estimate of value that you can count on.<\/p>\n \u00a9 2018<\/p>\n [\/fusion_text][\/fusion_builder_column][\/fusion_builder_row][\/fusion_builder_container]<\/p>\n","protected":false},"excerpt":{"rendered":" [fusion_builder_container hundred_percent=”no” hundred_percent_height=”no” hundred_percent_height_scroll=”no” hundred_percent_height_center_content=”yes” equal_height_columns=”no” menu_anchor=”” hide_on_mobile=”small-visibility,medium-visibility,large-visibility” class=”” id=”” background_color=”” background_image=”” background_position=”center center” background_repeat=”no-repeat” fade=”no” background_parallax=”none” enable_mobile=”no” parallax_speed=”0.3″ video_mp4=”” video_webm=”” video_ogv=”” video_url=”” video_aspect_ratio=”16:9″ video_loop=”yes” video_mute=”yes” video_preview_image=”” border_size=”” border_color=”” border_style=”solid” margin_top=”” margin_bottom=”” padding_top=”” padding_right=”” padding_bottom=”” padding_left=””][fusion_builder_row][fusion_builder_column type=”1_1″ spacing=”” center_content=”no” link=”” target=”_self” min_height=”” hide_on_mobile=”small-visibility,medium-visibility,large-visibility” class=”” id=”” background_color=”” background_image=”” background_position=”left top” background_repeat=”no-repeat” hover_type=”none” border_size=”0″ border_color=”” border_style=”solid” border_position=”all” … <\/p>\n