You can have your business appraised. Or, you can have it valued. A business valuation is far more thorough and therefore holds a lot more accuracy than that of a business appraisal. Both however, are super important when either buying or selling a business.
The following blog will analyse the difference between a business valuation and a business appraisal to provide you with a better understanding of the two techniques used by business brokers.
A business appraisal
An appraisal is an estimate of what the business will sell for at a particular time and is usually based upon a rudimentary assessment of the business.
Usually, an appraisal is based on the normalised profit the business has demonstrated over the past few years, and applies to it a “multiple”, or return on investment, to determine the appraised value. “Normalised profit” is the reported EBITDA (Earnings Before Interest, Tax, Depreciation and Amortisation) adjusted for non-recurring or extraordinary items a buyer wouldn’t expect to incur.
The number of years used as a basis is influenced by the profit pattern over the period. If the business is relatively stable with moderate growth, a three- or four-year period may be used. But if the business has experienced rapid growth and has changed significantly over that time, a shorter period may be more appropriate. In the most extreme of cases, just the latest profit may be used.
In instances in which the business is particularly asset rich, the written down value of fixed assets is added to this value.
An appraisal can be performed by any broker, regardless of qualifications or experience.
A business valuation
This is a much more involved process. It’s significantly more thorough and comprehensive. A valuation really analyses the trading history of the business. A wide-ranging assessment of trading is conducted to understand the income the business generates and the expenses it incurs.
Valuations can be conducted only by qualified business valuers. That is a prerequisite for acceptance by the Courts. Valuers must have passed recognised courses and have the appropriate qualifications.
What is involved in a valuation?
Every expense has a story. So, a valuer needs to find the underlying cause of each story. This usually requires a lot of investigation.
Income and gross profit also tell a story, so the valuer really needs to assess the numbers. The valuer is looking for changes in gross profit margins and revenue. And they’re looking to see if, for example, prices have been discounted to increase sales and reduce the GP%, or if additional advertising has increased sales, but has also increased expenses.
The valuer will assess wage and occupancy costs and compare them against industry benchmarks. They’ll also ensure that the business is compliant with all legal and best practice requirements.
In addition, they’ll be on the watch for extraordinary income or expenses and will adjust the bottom line for any that are disclosed.
They will also consider the balance sheet. It provides so much information on the entity which owns the business and the business itself. For example, it discloses how much stock is carried, what employee entitlements exist and what level of “working capital” is required to operate the business on a day-to-day basis.
It provides an insight into how up-to-date payments to third parties are. Obligations to creditors, the Tax Office and lenders are revealed by a Balance Sheet. And all of them can affect value. Even though it should be, the balance sheet is all too often not considered when simply appraising a business.
After assessing the statutory reports, the valuer will look at market evidence to see what sort of multiples of earnings, rates of return, or capitalisation rates are being paid or expected in the market.
This will then enable the valuer to “plug in” the profit and the capitalisation rate to a valuation formula to determine a value.
Market evidence is one of the most important parts of assessing the value of a business. It’s not easy to find. Nor is it easy to assess or understand.
Finally, when valuing a business there can be different reasons and requirements which will impact the valuation. For example, the valuation of a minority stake holding in a business is different to that of a business valuation. A minority stake in a business is usually less valuable.
It’s a fact that the majority of business owners only think about valuing their business when they’re preparing to sell. But knowing the value of your business is important. For example, it can shed light on areas that need improving. It’s a valuable tool in the ongoing analysis of a business.
So, whether it’s a straightforward exercise, or one that’s more complex, it’s a good idea to have your business valued with some regularity. To find out more on the importance of health checking your business and different business valuation techniques on a regular basis, check out this blog.
Give us a call on 1300 366 521 and we’ll be pleased to assign one of our qualified valuers to assist you.
To find out more about Benchmark Valuers, visit our valuation website here.
About the Author…
Bruce Coudrey is a Gold Coast business broker and Principal at Benchmark Business Sales & Valuations. Bruce is a Registered Business Valuer and has acted as a court-appointed expert witness. He has been retained by State Government roads departments and local governments for advice and information relating to compulsory acquisition and compensation matters – particularly in relation to service stations and small businesses.
Thinking about selling your café or business? Contact the team at Benchmark Business Sales today.
Read more about Bruce Coudrey here.
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