Definition

By definition business valuation is the process that is used to determine the financial value of a closely held company. For large publicly traded companies the process of determining a value is found by using a simple formula. Since publicly held companies fall under free market economics, and allow the laws of supply and demand to set a proper price for each share of that company’s stock, you can take the price per share and multiply it by the total shares to determine a value. (Price x Total Shares = Value)

If you were to try this formula with a closely held company you would be unable to complete the process due to the lack of the market setting a share price. Without this you do not have all data required to complete the formula. Business valuation is more art then definitive science, in which methods are used to find the proper value through the use of complicated equation calculations. Many owners try to use a “Rule of Thumb” method to calculate one of the methodologies and use this number as their value. They need to understand that if they are using this in an IRS case or for litigation they will find that it will not stand up to the scrutiny of either.

Process

Any business valuation will start with the gaining of an understanding of the company you are valuing. No expert will ever know more about a company than the owner of that company. The following are the basic process stages in valuing a business:

  1. Figure out the purpose and use of the business valuation
  2. Analyze all financial statements
  3. Analyze statistical and comparative data
  4. Analyze both internal and external financial data and projections
  5. Use the Methods of Business Valuation to calculate value
  6. Determine the correct discounts and premiums

Most owners focus on the one or two numbers that make up the bottom line numbers on a day-to-day basis. The valuation process analyzes the total makeup of the company’s financial health and worth of the company.

Organizations

There are five widely excepted business appraiser organizations:

  1. The American Society of Appraisers (ASA)
  2. National Association of Certified Valuation Analysts (NACVA)
  3. The Appraisal Foundation
  4. American Institute of CPA’s (AICPA)
  5. The Institute of Business Appraisers (IBA)

Over the past decade the legal courts, the business community, and the Internal Revenue Service have become more reliant on these professional organizations and their professional standards. In the late 1980’s the main organizations established the Appraisal Foundation in order to implement uniform standards for business valuation. This was due to the massive Savings and Loan scandals in the earlier part of that decade.