Business Valuation Methods

A business appraisal or valuation can read as if it is written in a foreign language. It is—they are in accountants’ language. Here’s a short map to help you understand what methods most appraisers use: book value, market value and income analysis.

Book value means hard assets less the liabilities. This is the minimum value you can expect. It’s calculated based on information in the company books and financials. Also, an equipment appraiser may be required.

Market value depends on comparable sales. However, business sales terms aren’t common knowledge, or published for the general public’s review. So you can never be sure what was actually paid.

Market value can conflict with Arizona law, which states that the business must be treated as an ongoing concern. This is to prevent a situation where the spouse operating the business takes the position that the business is worth nothing because all he or she has to do is shutter the business and open up down the street.

Income Analysis and Why It Wins Out

Income analysis is based on multiple sources of financial and other asset data. The purpose is to show how much the company really earns and can expect to continue to earn over time. The final number represents a potential price that a buyer would pay to own the future income stream the business produces.

The ultimate goal of income analysis is this: To determine whether the business will earn an amount in excess of what the operator spouse can earn doing the same work for a third party. That “excess” is called goodwill. The income approach usually wins out over the other two methods especially for service business, for example, medical practices, law firms or accounting firms.