Aside from special cases, many CPAs and accounting professionals probably need some clear guidance when clients want to know how much their business is worth, says Hector Garcia in Accountingweb.
To be fair, if you offer business valuation services you know that arriving at an answer is very difficult because 90 percent of a business’ value comes from qualitative attributes rather than just the numbers. Many accountants may guess that the value of a company is only based on its book of business.
For example, in your own firm, if you were to try and put a price on your sales tax consulting and compliance services, how much would the firm be worth? That would be difficult to estimate.
I think the answer can be based on six different measurements:
1. Book Value: the value on the balance sheet, which the total amount in the equity section of the balance sheet.
2. Fair Market Value: start with the Book Value, and then add or subtract the Fair Market Value of all assets and liabilities in the balance sheet.
3. Liquidating Value: start with the Book Value, and then add or subtract the value you would get from it in a “fire sale” scenario, using the same action systems used by foreclosures and bankruptcies.
4. Market Capitalization: the fair market value of the outstanding shares of the company owned by investors.
5. Going Concern Value: this is the value that a third-party investor is willing to pay for the business if it were to exchange hands – also known as “goodwill.”
6. Synergistic Value: this falls into the abstract thought process where 1 + 1 = 3 makes sense. In a nutshell, this is the value to the buyer of the business. This additional value is the potential created by the joining of forces from two teams, and/or combining assets, technology and strategies.
To offer future explanation, in Synergistic Value, there is the potential uptick in value because the buyer could consolidate operating expenses from the newly acquired business into its current infrastructure, while keeping the upside of the sales and gross profits. In addition, Synergistic Value is more of feeling (intuition) than a number.
A perfect example would be Facebook buying Instagram because no real financial model would have deemed the purchase as a sensible financial move. However, Facebook is either betting that the two technologies get exponentially better under one roof, or the purchase was done to protect its asset and prevent the average user from leaving the platform to use Instagram only. Indeed, sometimes the synergy is to protect the large sluggish Goliath and then to be disrupted by the very nimble David.
Going Concern Value isn’t really a widely uses term, but it is the most subjective of all six. Book, Fair Market, Liquidating and Market Cap are balance sheet methods and all could be done using quantitative methods, so in theory, an accountant and/or an appraiser could calculate the first four. The Going Concern Value assumes that there is “goodwill” added to the market value of your assets and that “goodwill” is 100 percent subjective.
11 Components of Business Value
That being said, let’s now ask a better question: “How would a potential successor determine the value of my business?” The answer to that will come from analyzing the areas that affect the client company’s Going Concern, which is the assumption that the business will continue to be solvent, plus the rate of growth.
1. Retained Earnings: typically represented in past profits that are accumulated and kept in the business (not distributed), also known as accumulated cash on hand from profits, and are free of debt or other encumbrances. Income growth potential is the most important element of quantifiable value because this is what drives most of the value. However, projecting that growth is based on more subjective figures driven by the other 10 components of business value below.
2. Income Generating Assets: real estate is the perfect example of this, but there are many types of assets that generate recurring income with very little operation required for them to function.
3. Infrastructure: tangible assets, systems and/or technology that give the company the platform from which to serve its customers and generate income. Amazon’s website is a great example.
4. Customer List: a list of past satisfied customers who are likely to buy from you again, or a customer list with recurring income or standard contracts that can reasonably guarantee some sort of income or sales in the near future – barring some sort of catastrophe.
5. Creditworthiness: how is the credit with banks, investors and private lenders? Vendor relationships, credit limits and credit terms play into this as well.
6. Brand: recognition and awareness from customers and potential customers for what the company does. I like to think of “brand” as what the customers think of the business and products before they buy them. The perceived quality of a company’s products and services are also part of the brand.
7. Intellectual Property: the knowledge base of the internal procedures, processes and know-how that are particular to the business.
8. Talent: the capabilities of the employees that a new employee would not be able to perform in the short-term. Corporate culture, leadership/bench and employee retention are all important components because they permeate to customer service and the quality of the product/service provided.
9. Location: this is not only physical location – which is most important for retail and customer-facing type businesses – but also refer to the web presence, search rankings and/or website traffic. In addition, distribution channels are very important.
10. Intangible Rights: some companies have special licensing, permits, contracts, geographic protection and trademarks that are unique and have high barriers of entry from competitors. Enforceable non-compete agreements are also valuable here.
11. Social Platform: the communications platform the company enjoys as part of its contact list, social media and other list of connected people who are referred to as “followers.” However, these are not necessarily coming from actual customers, but are part of a network of potential customers who create word of mouth about your business.
Adding up the tangible value plus the potential value (intangible) will help a business owner understand where the value of the business comes from. Whether you offer advisory services, tax or accounting, or other consulting services, you can now be ready to answer the question of “worth.” Good luck!