For a business valuation, different Standards of Value are defined differently but the application of approaches and methods may be different.

Definition of Fair Market Value

“… as the price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts.”[1]

For instance, in the case of fair market value, the buyer and seller are assumed to be hypothetical and the transaction is assumed to take place under normal conditions (as opposed to under duress).  In other words, the standard of value addresses the question of “value to whom?” and “under what circumstances?”[2]

Generally Accepted Business Valuation Practices

Fair Market Value is typically the most used standard of value.  When using Fair Market Value to determine the value of a business, there are several assumptions to be considered:

Approaches and Methods – The Asset-Based, Market and Income Approaches should be considered. The Discounted Cash Flow method is considered to be the most theoretically correct of all the valuation methods because it is the most precise.

Footnote for CDF: [1] https://www.securedocs.com/blog/5-common-business-valuation-methods

Basis of Accounting – The basis of accounting for a business valuation is the accrual method.  The accrual basis lets you see a full picture of your business’s finances.  This is because you track receivables and payables rather than just money that has been deposited in or deducted from your accounts.  It provides a more accurate picture than Cash basis of accounting.[3] 

Benchmarking – Benchmarking in a business valuation is comparing the performance of your company to other companies in the same industry (if the information is available).

Determining Cost of Capital – This is determining the results of financial performance of companies.

Benchmarking Data – The benchmarking data is generally accounted for on an accrual basis of accounting.

Consistency – If there is no consistency in the methodology to perform a business valuation by experts, they will not being performing the work expected of them and will obtain different conclusions than experts that use generally accepted valuation practices.

Conclusion

These are a few items that should be considered when performing a business valuation.  The benchmarking of cash basis financial statements to accrual basis benchmarking data will not provide an accurate indication of the company’s financial performance.

Summary

I help attorneys by converting complex financial matters into understandable concepts.  This makes it easier for the attorney explain the complex issues to their clients.

I have earned the most difficult business valuation designations for valuations of closely held companies.

I have earned a Master’s Degree in Business Valuations and apply those skills to my everyday business valuations.

Richard Claywell has been valuing closely held companies since 1985.  He has earned two of the highest designations in the business valuation field , the Certified Business Appraiser (“CBA”) and Accredited Senior Appraiser (“ASA”),  Richard is a Certified Public Accountant, has a Master’s in Business Valuation (MBV)  and holds the ASA, CBA, ABV, ICVS, CVA, MAFF, CFD, ABAR, CVGA, ICVS-A credentials.

I welcome and encourage comments and feedback. If you are benefiting from this series, please recommend to your friends and colleagues and suggest that they sign up to receive posts regularly.

[1] Revenue Ruling 59-60, Section 2.02.

[2] Pratt, Shannon P., Niculita, Alina V. “Valuing a Business: The Analysis and Appraisal of Closely Held Companies”, Fifth Edition, 2008, p. 41.)

[3] https://www.businessnewsdaily.com/16479-cash-accrual-accounting.html