Tuesday, May 20, 2014
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.