About Business Value Analysis | eHow.com

About Business Value Analysis | eHow.com

The basic concept of the value of a business is very simple. It is equal to the net present value ("NPV") of the income and/or profits the business is expected to generate in the future. However, the analysis required to make an accurate calculation of such a value is very specialized and time consuming.

Calculation Example
1. The following is a simplistic example of an NPV calculation. Assume the business: (a) has a remaining life of five years, (b) will generate $250,000 in income and/or profits annually for each of the remaining years, and (c) is associated with an annual discount rate of 10 percent. Therefore, the NPV of the business would equal $947,697.

Analytical Uncertainties
2. The analysis required to derive reasonably accurate numbers to use in the NPV computation, however, is far more complicated. Very sophisticated analysis is required to derive the numbers to input into the equation. Even after such an analysis is conducted, however, these numbers are estimates and not precise figures. Therefore, these numbers are always subject to varying degrees of uncertainty for several reasons.

Uncertainty 1: Continued Business Operations
3. First, even if the business has been operating for a long time and the historical financials are known, analyzing the future profitability of a business is uncertain. As every businessperson surely knows, historical performance is not a precise measure of future performance. Therefore, an analysis of the future prospects of the business essentially must be made based on a uncertain forecast of future economic, business and industry performance and the impact of these factors on that business.

Uncertainty 2: Future Business Sale
4. Second, the number of years the business will continue operating is also uncertain. It is possible that any business could go out of business in the future. Even if the likelihood of continued operations is virtually assured, the owner(s) could sell the business at some point in the future. Consequently, the number of years to specify in the NPV equation is always uncertain. If the business may be sold in the future, the income figure to use for the final year must be the sum of the net sales price proceeds plus the annual income plus the profit.

Uncertainty 3: Discount Rate
5. Finally, the proper discount rate must be estimated. The proper discount rate that is generally used is the long-term investment return of the receiver of the valuation, adjusted for risk. For example, the owner/operator who plans to continue operating the business would likely use the long-term historical return generated by that business, subject to any expected change in future risk of operating the business. Similarly, the owner that plans to sell the business would likely use the same long-term return. The prospective buyer of the business, will value the business based on the long-term historical return on his other investments and adjusted for risk.

Where do you get an appropriate valuation if you don't believe you are qualified to make this analysis? The business valuation services market includes professional valuation consulting firms, accounting firms and online valuation experts. There is a lot to choose from.

Valuation Services Market
6. Where do you get an appropriate valuation if you don't believe you are qualified to make this analysis? The business valuation services market includes professional valuation consulting firms, accounting firms and online valuation experts. There is a lot to choose from.


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