Over the years I have seen many appraisals from many different appraisers. I have been totally surprised by the wide variations of methods and the accuracy of these appraisals.
Appraising businesses accurately is not an easy task. There are about five different methods that can be used along with variations in the purpose of the appraisal. None of these methods addresses the total value of a business by its self. One method might look at cash flow value another at asset value and another at a capitalization rate. It is up to the appraiser to pick the appropriate method or give each of the methods used a percentage of the final value. Purpose also changes, as an appraisal done for the sale of a business will be different than one done for a divorce. Also, the IRS has certain requirements that must be followed for any appraisals submitted to them for such things as change in corporate structure or family trusts.
Financial statements and tax returns can create problems. Financial statements are always different, and tax returns don’t always match the financial statements. I can spend hours going through the documents, talking to the business owner or the business’ accountant looking for answers. To do an accurate job on the appraisal I have to understand these documents completely and how they relate to each other.
There is a wide variance in the quality of business appraisals mostly because of lack of experience. It is easy to pick up an accounting book and find the different methods of doing an appraisal, picking out a formula and plugging in some numbers. This process doesn’t necessarily give you an accurate appraisal. Most accountants know this and turn to an experienced Business Appraiser for an appraisal. Also, be aware that there are appraisers that stuff the appraisal with irrelevant and highly technical information to exaggerate the complexity of the appraisal or over inflate the appraisal to make an owner feel he has a high value business. With a growth in the internet, we now see “fill in the blanks do it yourself” business appraisals. It is not possible to get an accurate business appraisal this way. There is no way to provide a short cut to an accurate business appraisal.
I use a blended method of appraisal consisting of cash flow, asset value and market analysis. This blended method evaluates all items that create value in a business. I never have to guess if I am using the correct method or find percentages to use for each component. I have successfully used this process for over 25 years for business sales and business appraisals. My goal has always been to provide clear, accurate and affordable appraisals that meet the needs of my clients.
Robert A. Klein
President Business Appraisals
Monday, June 20, 2011
Friday, June 10, 2011
A Guide to Business Appraisals
There are a number of standard appraisal methods used to value a business that include, Asset approach, Income approach, Market approach (Comps), Capitalization of Earnings and Discounted Future Earnings. Each one of these methods individually does not always represent the true value of a business. We have seen appraisals where the derived value of these five different approaches varied by 500%.
Also used are Rule of Thumb values based on multiples of adjusted profits or percentages of gross sales. The rule of thumb methods only work when there are many similar businesses having the same operating expenses and assets. This doesn’t always happen and when you use the method on more unique businesses it just doesn’t work.
Using Comps tends to give the average value of the compared businesses and not the value of the business being appraised.
Capitalization of Earnings and Discounted Future Earnings are less often used and tend to end up with values that also tend to give the average value of the type of business.
After working with the standard methods for some time and evaluating what creates value in a business we learned that combining the Asset, Income and adding market influences into a single method gave an accurate market value. Having been involved with our own Business Brokerage for over twenty years we were also able to look at the businesses we sold and adjust and refine the combined method to reflect a True Market Value Appraisal.
The next step was to find a way to keep the through detailed analysis of the business being appraised and present it in a simplified easy to read manner. By looking at the components of a business that created value and categorizing them into Income, Assets and Market related we were able to create an Excel program to present the appraisal. The program was designed to be flexible so that it can be changed to meet different types of businesses and the many different purposes for business appraisals. This system may look simple but the complexities of doing an appraisal are still applied. There are many things that we still consider that are not listed in every report. When they are needed we add them into the Excel program.
Appraisal Requirements
For an appraisal system to work it must address the following:
1. the profitability of the business
2. the tangible assets of the business
3. the presence of intangible assets
4. the value derived should represent the market value
5. have flexibility to allow for the terms of a sale.
6. simplicity - Usable and understandable.
The first step was to determine what components in a business have value. These are some of them:
1. a functioning business with modest growth
2. skilled employees
3. working equipment
4. adequate usable inventory
5. a quality product or service
6. a profit
7. collectable receivables
8. a broad customer base with no very large customer
9. some new product development capabilities
10. a good reputation (name) in the market place
11. a clean, adequately sized work area
12. a financially sound operation with a good accounting system
13. the business located correctly for its market place
14. a good base of suppliers
After building this list it has to be divided to fall into a profit/asset based appraisal system. They are categorized as follows:
1. Profit based items.
a. business profit
b. a functioning business
c. business size - gross sales
d. intangible assets
1. skilled employees
2. a quality product or service
3. a broad customer base - customer list
4. new product development capabilities
5. a good reputation - business name
6. good financial management
2. Asset based items:
a. inventory
b. equipment
c. receivables
d. contracts
e. patents
f. trademarks
g. real estate
By Robert A. Klein, President and owner of Business Appraisals, providing business appraisals on all types of businesses. Former President and owner of Business Search, Irvine, California, a Merger & Acquisition firm specializing in the sale of manufacturing, distribution and related businesses, with programs for both buyers and sellers.
There are a number of standard appraisal methods used to value a business that include, Asset approach, Income approach, Market approach (Comps), Capitalization of Earnings and Discounted Future Earnings. Each one of these methods individually does not always represent the true value of a business. We have seen appraisals where the derived value of these five different approaches varied by 500%.
Also used are Rule of Thumb values based on multiples of adjusted profits or percentages of gross sales. The rule of thumb methods only work when there are many similar businesses having the same operating expenses and assets. This doesn’t always happen and when you use the method on more unique businesses it just doesn’t work.
Using Comps tends to give the average value of the compared businesses and not the value of the business being appraised.
Capitalization of Earnings and Discounted Future Earnings are less often used and tend to end up with values that also tend to give the average value of the type of business.
After working with the standard methods for some time and evaluating what creates value in a business we learned that combining the Asset, Income and adding market influences into a single method gave an accurate market value. Having been involved with our own Business Brokerage for over twenty years we were also able to look at the businesses we sold and adjust and refine the combined method to reflect a True Market Value Appraisal.
The next step was to find a way to keep the through detailed analysis of the business being appraised and present it in a simplified easy to read manner. By looking at the components of a business that created value and categorizing them into Income, Assets and Market related we were able to create an Excel program to present the appraisal. The program was designed to be flexible so that it can be changed to meet different types of businesses and the many different purposes for business appraisals. This system may look simple but the complexities of doing an appraisal are still applied. There are many things that we still consider that are not listed in every report. When they are needed we add them into the Excel program.
Appraisal Requirements
For an appraisal system to work it must address the following:
1. the profitability of the business
2. the tangible assets of the business
3. the presence of intangible assets
4. the value derived should represent the market value
5. have flexibility to allow for the terms of a sale.
6. simplicity - Usable and understandable.
The first step was to determine what components in a business have value. These are some of them:
1. a functioning business with modest growth
2. skilled employees
3. working equipment
4. adequate usable inventory
5. a quality product or service
6. a profit
7. collectable receivables
8. a broad customer base with no very large customer
9. some new product development capabilities
10. a good reputation (name) in the market place
11. a clean, adequately sized work area
12. a financially sound operation with a good accounting system
13. the business located correctly for its market place
14. a good base of suppliers
After building this list it has to be divided to fall into a profit/asset based appraisal system. They are categorized as follows:
1. Profit based items.
a. business profit
b. a functioning business
c. business size - gross sales
d. intangible assets
1. skilled employees
2. a quality product or service
3. a broad customer base - customer list
4. new product development capabilities
5. a good reputation - business name
6. good financial management
2. Asset based items:
a. inventory
b. equipment
c. receivables
d. contracts
e. patents
f. trademarks
g. real estate
By Robert A. Klein, President and owner of Business Appraisals, providing business appraisals on all types of businesses. Former President and owner of Business Search, Irvine, California, a Merger & Acquisition firm specializing in the sale of manufacturing, distribution and related businesses, with programs for both buyers and sellers.
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