Business Valuation: Art Or Science

By: BuyTradeBiz.com

Seasoned professionals know this little known fact. Valuing a business is not completely a science neither is it completely an art. While there are many known and time tested method of valuing businesses, at the end of the day there are a lot of subjective elements that play a huge part in the valuation process. Several sophisticated methods can be used to estimate potential business valuations but finally it all come down to what the buyers are willing to pay.

Now let us look at the few methods of business valuation that are out there. One of the common approaches to valuing a business is the income approach. Under this approach the valuation is based on future discounted income of the company. This method relies on the accuracy of cash flow projections and will depend on the market conditions that will prevail. While a financial investor can feel good about knowing the returns the business will provide, in some industries this can be hard to predict. How many of us would have predicted the current financial meltdown we are experiencing and its impact on income & cash flows?

Another popular method of valuation is the Asset approach. This is more prevalent in industries requiring a lot of equipment and machinery. This method values the assets and liabilities based on a fair market value and includes any intangible assets and contingent liabilities and the business valuation is derived based on these factors.

The Market approach is also used to value a business where it is difficult to use either of the above methods. This could be because the company does not have significant assets and does not have a predictable income stream established yet. However there is perceived value in the market because similar businesses have been bought and sold in the market. Similar to real estate, prices of businesses sold that are similar to the business being valued can be used to estimate the valuation of a business.

All the above approaches are sound and estabilished ways to value a company. However once you choose a valuation method and go through the effort and arrive at the numerical valuation, the experienced appraiser knows the difficult task is to adjust the valuation based on various realities of the business.

Now that we have come up with a valuation, the business appraiser has to now adjust the valuation based on a host of subjective factors. These factors include; management strength or weakness, marketability of the business, prospects for the industry, technological and regulatory challenges facing the industry to name a few. Based on the business being valued and the industry it represents some or all of these factors may come into play affecting the valuation positively or negatively. Experienced business appraisers use all the factors to adjust the valuation so it can represent and defend the valuation when confronted by a buyer. This is the part of the valuation where, the appraiser can really shine. The appraiser can deflect a lot of potential challenges mounted by a would-be buyer, by identifying all the relevant factors, and addressing and handling them squarely and fairly in the valuation report.

At the end, the valuation is a combination of both purely numerical and financial factors combined with various subjective factors that add or reduce the valuation and coming up with the final valuation. So in our opinion, it is fair to say that the valuation process is somewhere between art and science. And the experts know it!

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