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The Importance of an Annual Business Valuation for Small Business Owners

General Business News

July 2013

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The Importance of an Annual Business Valuation for Small Business Owners

People who built their businesses from the ground up are often surprised when it comes time to sell and they receive a lower-than-expected valuation. In fact, many business owners have no idea how much their business is worth. Business valuations can be complicated, but the annual use of professionals such as certified appraisers can help business owners figure out where they stand and what they can do to improve the value of their business well before they even think about selling.

Many business owners will seek a business valuation when they start to contemplate leaving the business. Of course, business brokers perform valuations as one of the first steps in the process of marketing a business for sale, but there are many other reasons for owners to get business valuations as often as once per year. Valuations are vital in determining partnership interests – whether a partner is leaving the organization or a new partner is joining. A valuation can also be required if a business wants to raise financing or equity, perform a financial restructuring, get a loan or expand with new facilities. For business owners, a valuation might be needed for divorce litigation, disputes about estate and gift taxes, and especially if the business owner is considering retirement. Annual valuations can also serve to protect the interests of minority shareholders or allocate a purchase price among different assets. Most importantly, periodic business valuations let owners know the state of their business so they can make quick decisions on any proposals that concern the business.

Experienced professionals have several different methods to calculate the value of a business, and many CPA firms have certified appraisers. Generally, an asset-based valuation sums up the value of all the business’ tangible and intangible assets. This method tends to discount the company’s earnings potential, however, so it is most often used to evaluate troubled or defunct businesses. The market-based approach, on the other hand, is commonly used to evaluate sound, sturdy businesses. This approach requires a precise measure of the company’s earnings, which are then combined with a multiplier. The multiplier is usually based on several characteristics such as the business risk and the amounts by which similar businesses in similar locations are selling. Multiples have fallen considerably since the financial crisis, but some evidence shows signs of recovery. The third method, the income-based valuation, looks at the company’s future earnings potential by examining the present value of expected future cash flow. This method is often used in high-growth sectors of the economy, and some prospective buyers might view it with skepticism.

Developing a relationship with a person trained in business valuations can also help to pinpoint areas for improvement. The strength of a business’ management team is always important, but especially when a potential buyer is involved. A potential buyer must find a comfort level with the existing management team, especially if the buyer has a vision to improve operations or merge them with his own. Of course, buyers will also want to see a proven track record of profits and positive cash flow, combined with future earnings potential.

It is also important to emphasize the business’ internal structure. Having things organized enhances the value of a business. Books and records should be carefully maintained, facilities should be neat and clean and employee policies should be documented.

Finally, a person trained in business valuations can also help identify potential advantages the business has in the marketplace. Business owners can easily lose sight of the big picture. Developing a relationship with an experienced professional who can perform an annual analysis can provide the perspective a business owner needs to be able to make quick decisions and take advantage of the market.

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These articles are intended to provide general resources for the tax and accounting needs of small businesses and individuals. Service2Client LLC is the author, but is not engaged in rendering specific legal, accounting, financial or professional advice. Service2Client LLC makes no representation that the recommendations of Service2Client LLC will achieve any result. The NSAD has not reviewed any of the Service2Client LLC content. Readers are encouraged to contact their CPA regarding the topics in these articles.

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