Understanding What Drives Value in Your Business Valuation

When business owners and managers receive a valuation report, their instinct is often to skip straight to the conclusion to find out the company’s worth. However, the detailed analyses supporting that final figure frequently go overlooked, particularly when the valuation is for internal planning or financial reporting. Taking the time to delve into these underlying factors is a valuable exercise that can provide crucial insights into what drives the company's value.

Valuation reports should be written in clear, easily understandable language so that the user of the report can easily grasp the concepts. Appraisers also may personally deliver the valuation report in draft form and then sit down with the client to review the report and answer any questions.

This serves two purposes. First, it ensures that the valuation is based on accurate information. If mistakes or omissions are discovered, this meeting gives the appraiser one last chance to revise his or her conclusion. Second, the meeting can provide insight into ways that owners and managers can maintain — or help grow — the company's value in the future.

The American Institute of Certified Public Accountants business valuation standard (VS Section 100) provides a useful roadmap for valuation reports. Here are some relevant elements to review in order to get more from your valuation report.

The appraisal report may identify strengths and opportunities that can add value if acted upon. The report also may unearth risks and threats that need to be mitigated to preserve value.

Appraisers evaluate the subject company's historical financial information and compare its performance to similar businesses. This may include ratio, common-sized financial statement and time series analyses. When a company's performance is benchmarked against its peers, it gives owners and managers insight into its position in the market and provides goals to match industry leaders.

Appraisers may use the company's historic financial data to estimate future cash flow. In turn, this analysis can serve as a starting point for management's future budget and business plans. Alternatively, valuators may rely on management's future cash flow estimates. If so, owners and managers may ask whether internally-prepared estimates appear reasonable in light of the appraiser's research.

There are three approaches to valuing a business: the asset, market and income approaches. There are various methods under each approach. For example, two common methods under the income approach are the capitalization of income and discounted future cash flow methods. When reviewing this section of a valuation report, you should understand why the appraiser selected certain methods and discarded others. Then learn the mechanics of how the preferred methods were applied to your financial data to arrive at the company's value.

The most common adjustments to an appraiser's preliminary value estimate are for lack of control and marketability. When reviewing this section of the report, you should understand what these valuation discounts are and why they did (or did not) apply to your business. For example, it's common for appraisers to factor lack of control into cash flow estimates, rather than to take a separate discrete discount for lack of control. Other types of adjustments include key person discounts and swing vote premiums. If you see adjustments for these items, ask for explanations.

Some companies possess assets and liabilities that aren't used in normal business operations. Or they may have excess or deficit operating assets compared to other companies in similar business lines. Appraisers may need to add nonoperating and excess assets to their preliminary value estimates — or subtract nonoperating liabilities and deficit operating assets.

Appraisers factor external conditions in the company's industry and the local, national and global economy when valuing a business. This section of the report should provide more than boilerplate. It should explain how industrial and economic trends relate specifically to your business.

Appraisers offer an objective, outsider’s perspective on your business operations and potential areas for improvement. However, no one understands your business better than you do. When reviewing the analyses behind the appraiser’s conclusions, seize the opportunity to ask thoughtful questions and challenge assumptions. This collaborative approach deepens both your understanding and the appraiser’s insights, ultimately providing a clearer picture of what drives your business’s value.

Interested in learning more about CSH’s business valuation services and how we can partner with your organization? Connect with us today.