How is a Business Valued

How to Analyze the Value of a Business Evaluator

A business valuation is a process wherein the economic value of an owner’s interest in a business is determined. Valuation involves estimating the price financial market participants are willing to pay or receive, resolving disputes related to estate and gift taxation, divorce litigation and allocating business purchase price among business assets, and developing a formula for estimating the value of partners’ ownership interest for buy-sell agreements.

The standard of value and the premise of value must first be set before the value of a business is determined. The standard of value refers to the hypothetical conditions under which the business will be valued while the premise of value refers to the assumptions which are related to business concerns and the value of the business, which is based on the proceeds from the sale of all its assets.

Business valuation is dependent on standard of value and premise of value. In a business sale, both the buyer and the seller determine the fair market value of a business asset. However, these assumptions do not necessarily show the conditions of the market in which the business might be sold.

It is the business evaluator who prepares a report that describes the current national, regional and local economic conditions in connection with the business conditions where the industry belongs to. A financial analysis includes common size analysis, ratio analysis such as liquidity, turnover and profitability, trend analysis and industry comparative analysis.

The business evaluator compares the company with other business in terms of industry and looks into trends that affect the company or the industry over time. The evaluator also analyzes the company’s financial statements in different time periods to study the growth and decline in revenues or expenses, changes in capital structure and the like. This kind of analysis helps the evaluator in determining the discount rate and selection of market multiples.

The business evaluator uses different approaches in assessing the company’s finances. The income approach seeks to determine the fair market value by calculating the benefit stream generated by the company and the capitalization rate. The asset-based approach adds the sum of the parts of the business while the market approach compares the company with other companies in the same industry.

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