What makes valuing businesses different from valuing property?
When a buyer purchases land or buildings there is both a guarantee of tenure and a physical asset, however when purchasing a business a buyer often may receive no physical assets and the tenure will only be as strong as the current lease (if in fact a lease is being made available).
Even if the purchase does include physical assets (such as plant, machinery, shop fittings and stock) and/or intangible assets (such as patents, logos, brands, contracts, websites and special telephone numbers) the rationale for buying a business is rarely to access assets, but to access its future income.
A business entity is merely a vehicle that can produce future income, and the value of a business entity is directly related to the risk of being able to produce that income on a maintainable basis. Therefore, in order to establish the value of a business, it is fundamental that a business valuer accurately quantifies future income, or more correctly, Future Maintainable Earnings (FME), and then quantifies the risk of that FME being maintained.
This concept is fundamentally different from the valuation of real property where either a direct comparison to recent sales or a comparison to income yields is generally used. In fact, the very nature of the competitive business environment means that it is only rarely possible to compare a business to like businesses in a comparable locality and so business valuers must use different, but objective and consistent methodologies.
Business valuers commonly employ three approaches to establishing business value, and will often reconcile the indications derived from two or more of these approaches and associated methods.
1. A Market Approach to value compares the subject business to similar businesses, business ownership interests, or securities that have been sold in the open market. The comparable businesses are in the same industry as the subject business and responsive to the same economic
variables. This requires that a database of comparable sales evidence is available to the valuer.
2. An Asset-based Approach to value examines all assets, tangible and intangible, and all liabilities at market value. The asset approach to value is based on the theory that the current value of all assets (tangible and intangible) less the current value of the liabilities should equal the current value of the entity. With this approach, a current Balance Sheet is the valuer’s best friend.
3. An Income Approach to value calculates the anticipated value of present income or benefits in view of their expected growth and timing, and the associated risk. Income is converted into value either by means of direct capitalisation of a representative income level, or using a discounted cash flow analysis method. The bulk of Australian businesses are unlisted, privately owned, micro or small-tomedium enterprises, and their value is usually determined by using an Income Approach; with the most important determinant being to establish an appropriate capitalisation rate to apply to the FME.
This is the part where a business valuer really earns his/her keep and requires a thorough understanding of both the operational and competitive environments in which the business operates. Accountants can assist a valuer in this regard by supplying comprehensive financial and payroll records for a business, as well as any supporting documentation relating to its operational and marketing efforts.
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