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Step
2 - Business Valuation
Business
Valuation Terminology
Here
is a review of the basic words and phrases related to business
valuation terminology. Some of these terms are used in many
different accounting contexts, but are defined here specifically
in the context of valuing a small business for sale.
Book
Value - When referring to your business as a whole, book
value is the difference between the total assets and total liabilities
recorded on your balance sheet. It does not include intangible
assets such as customer lists, copyrights or goodwill. When
referring to a business as a whole, book value is synonymous
with net book value, owner's equity and net worth. In an owner-managed
business it is common for the book value to be zero or negative,
due to the owner withdrawing cash and other property for their
own use.
Capitalization
Rate: The
percentage by which future income is divide in order to determine
it's current value. A capitalization rate can also be stated
as a multiple of earnings by using it's reciprocal. A 25% capitalization
rate is equal to a multiple of 4 times earnings.
Discounted
Cash Flow - The stream of income that will be paid or generated
by the business in the future reduced to its present day value
by applying a discount rate. Or to put it another way,
"what is the value today of the cash the business will
generate in the future?"
Discount
Rate - The rate of return used to determine the present
value of cash the business will generate in the future.
Earnout
- A portion of the purchase price that is contingent on future
performance. It is payable to the seller after certain predefined
levels of sales and/or income are achieved in the years after
the sale.
EBIT
- Earnings before interest and taxes.
EBITDA
- Earnings before interest, taxes, depreciation, and amortization.
Fair
Market Value - The most widely accepted definition of this
terms is: price at which an asset or service passes from
a willing seller to a willing buyer. It is assumed that both
buyer and seller are rational and have a reasonable knowledge
of relevant facts.
Going
Concern Value - The value of a company as an operating business
to another company or individual. The excess of going-concern
value over asset value, or liquidating value, is the value of
the business as distinct from the value of its assets. Going-concern
value in excess of asset value is treated as an intangible asset
and referred to as goodwill.
Goodwill
- An intangible asset that refers to the value of those unique
aspects of a business that don't have an easily determine monetary
value. Such assets may include the company's name, reputation,
well-known products, loyal customer base or especially attractive
location. Goodwill can be thought of as the premium the buyer
pays for the business over and above the value of the company's
hard assets.
Income
Approach - A general term referring to any method of valuation
that determines the value of a business based on future income.
Intangible
Assets - The intangible assets will usually consist of goodwill
certain types of intangible property that generally relate to
the workforce, information base, know-how, customers, suppliers,
or systems in place producing cash flow and proprietary rights
such as: patents or copyrights.
Liquidation
Value - The value of a company based on the assets of the
company being sold separately and not as part of an on going
business enterprise.
Net
Cash Flow: As it applies to business valuation, net cash
flow is what the business owners can take out of the business
without adversely affecting its operations.
Normalized
Earnings: The
actual earnings of a company after all unusual expenses and
non-recurring income have been removed from the figure.
Pro
Forma Statements - Hypothetical financial statements based
on projections of future sales and income.
Recast
Financial Statements: Since most small businesses are run
in a way that will minimize income taxes, the financial statements
don't usually reflect the true value the business creates for
it's owner. For example, an owner who pays himself and several
of his family members above market-rate salaries would
recast his financial statements to reflect the profits the business
would show with if market-rate salaries were paid. Click
here for a more detailed overview of recasting financial statements.
Sell
Your Business Tips, Hints & Techniques:
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your name & e-mail address below and each week I'll send
you detailed tips, facts, resources & ideas you can use
right away to help sell your business faster and for more money.
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