The Practical Applications of Business Valuations
Accountants don’t perform business valuations simply to stick a dollar figure on a business. They do valuations for clients who need a general idea of how much money a business is worth in order to make well-informed decisions regarding that business. Here are a few of the more practical applications of business valuations.
Negotiating a business purchase
The most basic reason to place a dollar figure on a business is to help sellers or buyers determine what they think is a reasonable price for the business. Imagine if you were considering buying a pizza restaurant. You’d probably want to take a look at the ovens, equipment, and furniture — and consider how soon those fixed assets would need to be replaced.
That analysis would help you determine what the business is truly worth to you, and how much you’d be willing to pay for it.
Securing a bank loan
Commercial loan officers work with loans to businesses. The loan officer is concerned about the company’s ability to generate enough earnings to make the interest payments on the loan and repay the principal amount borrowed.
If a valuation based on earnings shows the company’s earnings are trending higher, the business is likely to be in a better position to make loan payments in the future.
Say, for example, that your firm has a $2,000 monthly interest payment on a loan. The interest payment would be less of a burden if your earnings were $50,000 a month versus $5,000 a month.
Explaining a company’s value to investors
Businesses often raise money by selling shares of the business to investors who want to know the value of what they’re getting for their money. Unfortunately, the balance sheet may fail to reflect the true value of a particular asset or exclude the value of certain assets.
For example, suppose a company purchases a time-saving machine that will eventually save it far more than the cost of that machine; the machine is worth more than the dollar amount the company paid for it.
Assets that don’t even appear on the balance sheet are customers or clients. A business may have strong long-term relationships with certain clients that generate significant sales and earnings, but the value can’t be posted to the balance sheet as an asset. A business valuation takes this important asset into account.