Basic Elements of A Business Valuation Report | Accounting-financial-tax.com offers bookkeeping journal entry basic accounting financial accounting management accounting tax accounting cash management accounting cost accounting financial ratio budget forecasting

Basic Elements of A Business Valuation Report | Accounting-financial-tax.com offers bookkeeping journal entry basic accounting financial accounting management accounting tax accounting cash management accounting cost accounting financial ratio budget forecasting

By Putra | No CommentsLeave a Comment | Putra is a CPA, formerly a controller for a corporation in Costa Mesa, CA
Last updated: Tuesday, August 3, 2010

Understanding what a business valuation report look a like is essential. It is no use if you know the business valuation bible without knowing how the reports look a like. Business valuation reports can vary in length and complexity based on the complexity of the job. The best valuation reports tell a story about the history of a business, its pros and cons, and most importantly, its potential. To note, business valuations aren’t driven by bricks and mortar sitting on a piece of land. They’re driven by the reason someone wants to acquire a business or get rid of one. An asset’s value is ultimately driven by the rationale for a transaction. And the goal of any valuation (regardless of the purpose) is to answer the question “What would happen in the market?”

This post describes the basic elements of a business valuation report. Please note: (1) No two reports, like no two business valuations, should ever be the same; (2) The aim of this post is not to teach you how to make a business valuation report. Rather, it focused on how to read a business valuation report in determining what a business is worth. But, by watching the habits of appraisers, accountants, and estate and tax attorneys, I believe you be gaining insight, too.

What a Business Valuation Report Is Supposed to Do
A good valuation report, like any piece of quality research, should open reader’s mind to possibilities you’ve already considered and maybe a few you haven’t thought about. Putting dollar signs in business owner’s eyes isn’t the job of a quality valuation professional. Nor is it her job to search in every corner for value or for data, events, or hidden matters that may take value away.

A good appraiser’s job is to provide a third-party, objective opinion on what would actually happen if the subject company were for sale on the open market. The business owner’s that having valuation get a median valuation as the result, but if the appraiser or valuation professional is doing her job, you get what’s known as a range of values, a compilation of opinions based on various methods of valuing those assets.

Typical Business Valuation Report Outlined
Every valuation professional may have a particular style, but most valuation reports follow a certain structure. I’ll cover each section of the report in greater detail in the next subsections. For now, though, take a quick look at the setup:

Cover
Valuation summary (including assumptions and limiting conditions)
Table of contents (though, it does not need to describe about this part)
Executive summary
Valuation summary
Valuation assignment
Economic outlook
Industry outlook
Business overview (including cost of capital, discounts, and premiums)
Conclusion of value
Appendixes (charts, footnotes, glossaries, and more)

A valuation report has no set number of pages. The length depends on the complexity of the assignment and the valuation possibilities based on the valuation goals being sought. The next paragraphs describe each of the elements. Read on…

Cover of Business Valuation Report
A cover’s a cover, right? Well, in addition to looking at all the key information about the valuation firm, its contact information and where it’s located, and its cool logo, you would find one piece of key information and make sure you understand it: “the Date.”

Know whether the printed date is simply the date when the report was turned over or whether it reflects the official date of the valuation. Reader should be very clear about all the critical dates in any valuation report. The valuation date is critical because if this report is being done for tax reasons or eventually becomes evidence in a lawsuit or divorce action, the time sensitivity of the analysis becomes all the more important, depending on the circumstances of the case.

The Valuation Summary
Unlike mystery novels, readers don’t have to flip to the end of most valuation reports to figure out what happens. They can pretty much flip past the cover and the table of contents, and then, boom—they find the number they’ve been waiting for. It looks something like this:

The fair market value of XYZ Inc. is $1.2 million based on a weighting of income and market valuation methods.

Note the phrase “weighting of income and market valuation methods.” This particular company was valued based on the income approach and market-based comparisons. This fact may not be true for every business, which is why reader need to do they homework about what kind of valuation approaches and methods best fit a business in their situation.

The rest of this section of the report usually delivers the following kinds of information:

1. The assumptions and limiting conditions of the business - This section is a statement of assumptions and conditions on which an appraisal is based that the appraiser may or may not have verified. A standard valuation may contain a statement that describes items such as the following:

That the title and legal description of the business are correct
That the property is free and clear of liens
That the current management and ownership have been verified and declared responsible for the business
That the factual information received from others in the course of creating the report is reliable
Notes on the illustrative material
Any environmental impact statements that may be relevant
That all licenses necessary to operate the property have been obtained
That there is evident compliance with zoning and land use regulation

2. Executive summary - Everyone likes summaries. The executive summary enables readers to see the critical points in the valuation process.

3. Purpose of the valuation/ownership structure - This section tells readers the assumption of ownership upon which reader basing the valuation. If this business is a target company and they want to own 100 percent of it, that situation requires certain assumptions and valuation methods of its own. Of course, if they’re valuing a portion of the ownership instead of 100 percent (if they’ll have a business partner or two, or if they’ll own jointly with a spouse or other family members, for instance), they’ll see more details on what discounts or premiums have been added to the computations to affect that total valuation. In the business valuation context, discounts or premiums are facts that either enhance or diminish the salability of a business and, therefore, the amount of value.

4. Standard of value - The standard-of-value section can be combined with one of the opening sections. Regardless, the business owner need a statement of the standard of value used to create the valuation. Fair market value, fair value, strategic value, and intrinsic value all result in different value conclusions based on the type of company being considered. The subject of valuation and standard of value also helps determine whether the business owner need to take various discounts, including discounts for lack of control and lack of marketability, as in the case of valuing minority interests in a company. If the business owner have had his/her business valued in recent years, they should keep in mind that the same standard of value and methods may not apply based on his/her goals for this valuation. In other words, he/she should let the goals and the current structure of the company govern which methods to use to complete the valuation, and doesn’t make decisions based on decisions he/she made before.

5. The valuation date - This section covers the particular date the valuation was done. All valuations must be set on a particular date to allow the valuation professional to freeze a company’s conditions and financials at a moment in time.

Valuation Assignment
Describing the assignment after seeing the numbers may seem a little backward, but readers often want to see that dollar figure first. This section of the report talks more about the features of the company itself. Here is the content of this section:

1. The valuation key assumption - In a report that aims for clarity, if the business owner see something here he/she would call the valuation key assumptions. Granted, the business owner may want to value a business because he/she’s thinking of selling, but valuation professionals think a little differently. They look at all the assets business have and make an assumption based on what they think is the best way to monetize those assets. The valuation professional may state here that the sum total of assets would be best sold as a whole —as in a sale of the company outright—or may state that the assets would attract more cash if sold separately.

2. The assigned valuation date – I have mentioned how important the valuation date is. Who sets the date? Optimally, the party who request the valuation (it could be the business owner or the acquirer or their representative) does. Competent valuation professionals don’t set the date because it’s not their job to decide the critical facts of the valuation, and the valuation date may be among the most critical. Timing issues should be the purview of buyers and sellers, not people who value companies. In other words, companies that are planning to go on the block immediately may want the most recent numbers for the company figured into their valuation picture, particularly if those numbers are perceived to enhance the value of what they’re selling.

To be clearer on the important of the valuation date, let me explain it further. Companies that want to obtain bank financing or equity participation in their business may want to set different timelines. Qualified valuation professionals typically insist on a written recommendation from the client or the client’s attorney specifying the exact valuation date. That way, they never have to redo the assignment; if the date is wrong or changes for any reason, the client or the client’s attorney then must start the process all over again.

Dates can be a critical factor in the valuation process. Divorce, estate, and gifting issues are examples in which valuation dates certainly matter. As for the ordinary buying and selling of companies, the date doesn’t matter as much, but a date must be set at some point. For example, the initial valuation of a company may be based on the last full year of financials for analysis in a report, but eventually, the year-to-date performance of a company will have to be communicated to be part of the report or not. A smart buyer or a banker considers any data more than 90 days old to be outdated.

Economic Outlook
Anyone can watch business channels and read as much as possible about the general state of the economy, but a business valuation professional has to know how to apply that macro view to the micro world of the business having valuation.

When various segments of the world economy experience either good times or downturns, valuation professionals can’t turn a blind eye to those trends. They must pay full attention to anyone a company is doing business with or competing against.

In a valuation report, business owner should see detailed notes on how the economy is playing out, both in general and in particular in your sector of business. Here is most important point describes on this section:

1. GDP - The gross domestic product is the value of all the goods and services produced within a given year. The GDP is a crucial way of measuring how free businesspeople feel to invest in their businesses and increase production.

2. Interest Rates - People watch the Federal Reserve Board closely for a reason: It sets the general course of what borrowers will pay at all levels of the economy. Banks, businesses, and ordinary individuals find it easier to borrow and increase their spending when credit is looser; when credit is tighter, they slow down. Valuation professionals should bring this trend down to the level of the client who has to borrow in a particular economic climate.

3. Commodity Prices and Exchange Rates - If a business works with particular raw materials, such as metals, foodstuffs, or energy products, it needs to know how costs for those particular items will affect the cost of production in the business’s area. Likewise, exchange rates—a reflection of the value of world currencies—can have a detrimental or a positive effect on a company’s operations overseas. Valuation professionals need to know where these trends are heading and whether those measurements will increase or decrease valuations over a stated term.

4. Government’s Policy and Political Considerations - Political and policy considerations are also important drivers of the economy. What the president and the nation’s legislators hope to do with regulatory, tax, and energy policy is crucial to business. Again, valuation professionals need to know how federal legislation will affect state legislation that deals specifically with the business in question.

5. Key measurements - Depending on the size of the business and its industry, the valuation professional follow a market indicator that measures how your sector of the economy is doing. These indicators may include: (a) The NFIB Small Business Economic Trends report: The National Federation of Independent Business produces a series of research reports that describe how small companies feel about their businesses right now; and (b) Industry-specific indexes. Many trade publications have developed their own economic indexes to measure economic activity. Equally important, a valuation professional must understand how the competitors are doing.

6. The state of capital spending - Capital spending is a driver of economic growth. Reader want to see whether companies anticipate spending more to make investments in their business. Even more important is seeing where they’re going to make those investments.

7. The state of business financing in general - Most businesses need to have some relationship with credit. In valuing a business that preparing for sale/buy, a valuation professional needs to keep the overall credit environment in her mind.

Industry Outlook
Valuation professionals are supposed to shine the cold searchlight of truth on the state of the subject company’s industry. To value a company properly, it’s important to know what the leaders in the industry are doing, what their products are, and what their growth prospects are. Valuation professionals use news stories, database material, and a host of public and private company data to create this story.

As with the rest of the valuation assignment, the industry story isn’t told in a snapshot view of what’s going on during the latest year of business. Reader should see comparisons of revenue and operating profit growth for the industry over a certain period or whatever is appropriate in the context of that industry so reader can get an idea of possible three- to five-year prospects going forward.

Other factors that can be found in the industry outlook section of the report include the following:

1. Growth prospects - The valuation professional’s job is to give the reader an opinion on where the company stands on that growth path. If a reader is a thoughtful participant — or potential participant — in an industry, he/she owe it to himself to know something about that industry’s growth prospects and where the business in question ranks. Otherwise, how can he really trust the information other experts are providing him?

2. Potential threats and benefits for the overall industry - If the company being valued is a manufacturing company in a particular industry, such as computers or toys, readers will likely see a comparison made to the overall growth of manufacturing businesses in the national scale (or internationally as well, if that’s a necessary point of comparison). Some valuation firms develop their own proprietary systems and formulas to further analyze this issue; others simply report what they’re seeing in the news and from other trade sources that closely follow the industries. One is not necessarily better than the other.

Business overview
Readers may know the business, but they would want to see how the valuation professional describes what the business does. Reader want know how much the valuation professional know about the business. This section explains the parts of the report’s business overview.

The Median Value is Just a Convenient Midpoint; It doesn’t represent the revenue multiple for any actual transaction. It indicates that half of the revenue multiples are below the median value and half are above. Median values depend on the attributes of the business and the outside data points an expert uses to value it.

Basically this section contains the following points:

1. Overall financial performance - The overall-financial-performance section usually consists of a one-year summary of the target company’s financials, but the report also makes many references to the company’s financials over a multiyear period. It may be accompanied by a chart of three to seven years of the company’s financial performance.

2. How financials were adjusted/normalized (and for what purpose) - Valuation professionals adjust financial figures to accomplish certain goals or to facilitate certain valuation methods. These adjustments may be for one-time nonrecurring expenses such as a rare lawsuit or maybe capital expenditures from a flood or fire. The adjustments are typically derived from control adjustments. Put in simpler terms, one of the tax advantages of owning a privately held business is the ability to run certain expenses “through the business.” Owners may have family members on the payroll who aren’t essential to the operating of the business. Or they may be burying certain personal items that aren’t essential to day-to-day business operations. Examples include the following: (1) Cars and car insurance (also boats, airplanes, and vacation homes) (2) Personal travel and entertainment (3) Country club dues (4) Healthcare for family members.

When maximizing deductions for tax purposes, these control adjustments are common. As long as taxpayers are using them properly under the tax code, all should be well. But potential sellers should be prepared to open up their books because, many times, these control adjustments are major factors in getting to the cash flow used for the income approach. If people are playing fast and loose with how they’re preparing their taxes because they’re being overly aggressive with running personal items through the business, they probably need to take a year or two to clean up the financial statements before a sale or valuation.



3. Owner’s compensation - Assuming that this company is a small business with a single owner, the owner’s-compensation section is where readers see the company’s top salary benchmarked against that of executives at similarly sized companies in the same field. If this salary is above the range, it may be valued outside the expense side of the company’s normalized financials: If the business changes hands, a new chief executive walking in the door may not need to be paid as much. In larger firms with more top officers, reader may see a broader benchmarking of salary data. And what happens if a business owner isn’t paying herself a fair market wage for the size of her company or business? That in itself may indicate poor stewardship of the company acquirer may be planning to buy. And that’s another important reason to analyze compensation.

Conclusion of Value
The scope and depth of the valuation assignment determine how many valuation methods the professional employs in the valuation of the company. The report’s conclusion-of-value section devotes space to why each method was used and what computations were used to establish the standard of value.

Reader can see a narrative description of each method, along with a chart of the computations used in each method:

1. Methods examined and accepted/rejected - This section discusses the approaches and methods considered and rejected (and reasons why), as well as the approaches and methods considered and accepted to provide a reasonable conclusion of value.

2. Explanation of weighting each valuation method - Weighting is an indicator of importance—a ranking. Some valuation methods weight certain methods to reach a conclusion of value. Other reports do not. That decision depends on the school of thought or philosophy of the individual appraiser.

The next stop may be discounts and premiums. That depends on the scope, depth, and purpose of the assignment — and may also depend on the appraiser’s philosophy. In some instances, the discount and premiums are calculated within the method. And in some cases, they’re applied after determining the overall value. If they appear after the conclusion of value, the professional sets numbers for the following:

The firm’s control premium - This premium represents what an interested suitor — or existing shareholder — would pay to get majority control of a firm.
The firm’s marketability discount - This discount, a factor that actually decreases the value of a company, is tied to various factors that make a business tougher to sell.

Marketability discount is a natural issue for private companies because their shares do not trade on public markets and their value isn’t set publicly on a daily basis. Experts can apply various methods to come up with the discount that must be applied, including the restricted stock method, the IPO method, and the option pricing method. You may also hear about the liquidity premium — it’s an extra reward that investors demand for tying up money in the firm for a longer period of time than they may otherwise choose.

Appendixes
Here readers see specific information describing the expert and the valuation firm he works for, notes on exhibits and charts, and other descriptive material reader would see in any report. Some valuation firms list a specific glossary in the appendixes to make sure everyone understands the terms discussed throughout the report.