Making profits is the primary objective of most business owners. They do this by spending a great amount of time and energy on developing growth plans with well-defined goals and smart business strategies.
However, these plans and goals might be difficult to execute and achieve without knowing how much is the value of their business now and what kind of future value are they looking for? Thus, it is important for business owners to understand the value of their company as well as the factors that drive such value through business valuation.
Find out why business valuation matters and how it plays an important role.
What is Business Valuation?
Business valuation essentially refers to the unbiased process of determining the fair market value of its owners’ beneficial interest in the business entity – be it a privately held, public company, partnership or sole proprietorship. To put it differently, business valuation is all about assessing what would be the right value, not price for a business.
Value differs from price
- Value does not equal price which often is misunderstood. Price is subject to negotiation between willing buyer and willing seller in a free market. Investors may pay a premium or discount to the value of a business, depending on many considerations.
- Determining the value is the start of a price negotiation process. Without this independent process of determining its value, potential investors, creditors, sellers or buyers, and business owners will not have an idea of what is the exact value of their business before they start negotiating on the price.
Fair valuation measurement prevails book value
- In recent years, International Accounting Standards have also moved towards fair valuation measurement.
- No one uses book value to determine the worth of a business anymore because book value is derived based on historical past financials, whereas future value is a projected outlook of a business translated into present value.
- Financial reporting purposes include Purchase Price Allocation during business combinations and valuation of complex financial instruments like convertible bonds, employee share options (ESOS), warrants, preference shares, etc.
Different circumstances where business valuation is needed
- Other situations that require valuation are when there is a dispute or disagreement between the shareholders where the dissenting shareholder wants a valuation to determine the price to exit or it could be a majority shareholder who wants to buy out the minority shareholders.
- Also, there are instances when a shareholder has passed away and valuation is needed to assess the value of the deceased estate for distribution to its beneficiaries.
- A certified valuation report is required in order to split the matrimonial assets in the event of a matrimonial divorce proceedings where one party has a business interest.
- Sometimes, valuation could be for tax purposes for example, valuers are called upon to value acquired intellectual property rights (IPR) before they could be allowed to claim wear and tear allowances from the IRAS under Section 19B of the Singapore Income Tax Act.
- Other kinds of valuation work will be valuation of assets like specialised machinery and equipment like oil rig, biopharmaceutical assets, waste bin containers, ship vessels and jewellery items for purposes of raising financing from institutions.
Typically, for the reasons mentioned earlier, business valuation is needed to identify its current worth or value. Understanding this is crucial in any effort to make informed and strategic business decisions.
How does business valuation work?
Generally, business valuation is relatively simple and straightforward. The process usually involves hiring a qualified valuer who will analyse the financial statements of the company, understand its industry and business outlook, its key drivers of the business, and other relevant qualitative and quantitative information. Following this, the valuer will make applicable normalising adjustments to ensure that the company’s financial statements reflect the commercial reality before undertaking a comprehensive valuation calculation according to valuation methodology set down by the International Valuation Standards. This will then lead to a reasonable assessment of fair market value by providing an independent valuer’s opinion.
In a more profound sense, business valuation is conducted using three approaches: income, cost and market approaches. The most common of them is the income approach where the value of a business is measured by adjusting future cash flows to the present time value of money after taking into account various aspects such as risk, inflation, and cost of capital. Sometimes, valuers could use the cost approach, sometimes known as asset valuation – it basically estimates the market or fair market value of the assets held by a company either using the replacement or reproduction method.
Another valuation approach is the market multiples approach. This method attempts to establish the value of a company by comparing it to similar sized comparable companies or comparable recent transactions from publicly available databases. This approach usually works only if there is a sufficient number of similar companies in terms of capital structure and business model in order to make meaningful comparisons.
What benefits does business valuation bring?
Business valuation is performed for a myriad of reasons. For one, it provides business owners with an objective, independent, unbiased assessment of their company value in accordance with best practices recommended by the International Valuation Standards body. Even though sometimes, business owners may have an idea of what their businesses are worth through their own business interpretation, this is sometimes not sufficient to assess accurately how much their companies are valued because these views are subjective and without a proper basis that can be trusted. Most importantly, such valuations should be performed by an independent and qualified valuer who follows the valuation methodology and standards of the International Valuation Standards Board that gives the perceived confidence and trust because valuers adhere to ethical rules from the valuation associations who accredited them.
Aside from getting accurate data of a company’s value, if a business owner seeks additional investors to fund the growth of their company, the investors will most likely ask for a full business valuation report to aid them in their business decision. An independent business valuation report will provide assurance to investors.
Hence, it is necessary for business owners to always get their business valuation report ready.
Business valuation is important for many different reasons as mentioned above. However, if you’re unfamiliar with how business valuation is done – consult us today to assist you with this matter.
At Max Lewis Consultants, we hold the Chartered Valuer and Appraiser designation from Singapore and Certified Valuation Analyst/Specialist credential from the USA that can advise and help business entities get ready the necessary documents for business valuation. Besides this, we also perform valuation of assets, valuation of intangible assets, intellectual property rights, complex financial instruments like derivatives & Employee Share Options (ESOS) valuation. Get in touch with us for professional advice and guidance.