February 17, 2025 • 11 mins
What Are The Most Effective Methods For Determining A Business's Value?
Learn the secrets of business valuation with Tim Provost, a partner at MP CPAs, as we explore the complex world of determining a company's true worth. Whether you're eyeing investment opportunities or planning strategic moves like mergers and acquisitions, understanding business valuation is critical. Tim guides us through the three primary methods—market, income, and asset-based approaches—shedding light on when and why each is used. We delve into how factors such as comparable sales and growth potential influence these methods, and why accurate financial statements are the cornerstone of any valuation process.
Navigating the nuances of valuation for different scenarios, like gift tax purposes versus a sale, is essential for setting realistic expectations. Tim shares insights on preparing for adjustments due to fluctuating market conditions, helping you optimize wealth and safeguard future financial interests. This episode is packed with practical advice and expert knowledge that promises to enhance your financial strategy toolkit. Tune in for a deep dive into the dynamics of business valuation and learn how to leverage this knowledge to your advantage.
To learn more about MP CPAs visit:
https://thempgroupcpa.com/
MP CPAs
413-739-1800
Mark as Played
Transcript
Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Speaker 1 (00:04):
Welcome to the Knowing what Counts podcast, the
place where expert guidancemeets smart financial decisions.
Whether you're a high net worthindividual or a thriving
business, the experts at MPCPAsare here to help you protect and
optimize your wealth.
Let's get started, becausesuccess begins with knowing what
(00:25):
counts.
Speaker 2 (00:33):
How much is your business really worth?
Partner Tim Provost breaks downthe methods and key factors
that determine a company's value, helping you understand the big
picture behind the numbers.
Welcome back everyone.
I'm Sophia Yvette, co-host,slash producer, back in the
studio with Tim Provost, partnerat MPCPAs.
(00:54):
So, tim, how's it going?
Speaker 3 (00:57):
Good Sophia, how are you?
Speaker 2 (00:59):
I'm doing good.
So, tim, what is a businessvaluation and why is it so
important?
Speaker 3 (01:07):
Business valuations are important for a lot of
different reasons.
A lot of companies might use itto make investment decisions.
So if you're trying to securefunding, investors may want a
valuation to make informeddecisions about buying, selling
or holding an interest in thatbusiness.
You also commonly will seemergers, acquisitions and sales
business.
You also commonly will seemergers, acquisitions and sales.
(01:27):
Accurate valuations areessential for negotiations and a
starting point sometimes as tohow much you may buy or sell a
business.
Also, businesses may use it forstrategic planning.
So you know what ways can weincrease profitability?
Where are some of ourweaknesses?
Internal discussions such asthat.
You'll also commonly see it usedfor succession planning.
So you know adding new ownersto replace an existing owner.
(01:49):
You know passing on to yourfamily or whatnot, you're going
to want to know what thatbusiness is worth and what a
fair value might be for it.
Taxes is another great reasonfor estate or gift taxes.
You may need to get a businessvaluation to determine a
business's worth upon passing orif you wanted to gift ownership
to family or whatnot.
And then legal matters isanother common one.
(02:10):
You might have some legaldisputes divorce settlements,
shareholder disagreements,things like that that may come
into play where a businessvaluation is going to be
required to kind of settle thedispute.
Speaker 2 (02:21):
And so, tim, why don't you introduce yourself to
the audience a little bit?
Speaker 3 (02:26):
Yeah, I'm a partner here at the firm.
I do taxes working with highnet worth individuals, but I
also do business valuations here, so you know it gives us a lot
of different types of servicesthat we offer.
Speaker 2 (02:40):
What are the different methods used in a
business valuation?
You mind sharing that with theaudience?
Sure, yeah, there's threedifferent methods used in a
business valuation.
Speaker 3 (02:46):
You mind sharing that with the audience?
Sure, yeah.
There's three different methodsused in a business valuation,
three main ones.
You have what's called a marketapproach, similar to when you
sell your home.
You go out into comparableswith a real estate agent.
You're going to comparebusinesses to other businesses
within your industry that havebeen sold over the last five, 10
years or whatnot.
You might search severaldifferent databases to come up
with different sales.
That can be tricky to find,sometimes depending on your
(03:08):
industry, but that is one of themain approaches.
Income approach is another onethat's estimating the value of
your business based on yourability to generate future
income.
There's a lot of different submethods underneath that.
Two common ones would be adiscounted cash flow, which is
an analysis using futureearnings, and you also have a
capitalization of earningsmethod, which is looking
(03:29):
historically at your earnings.
And then, finally, you havewhat's called an asset-based
approach, that is, valuatingbased on your assets and your
liabilities, just looking at thebalance sheet.
Speaker 2 (03:40):
What about the advantages and disadvantages of
each method in a businessvaluation, and when would you
use one over the other?
Speaker 3 (03:49):
Sure, the market approach.
The advantages it's easy tounderstand.
I think a lot of people arefamiliar with buying houses and
understand that you brought intocomps and similar comparisons,
so it's easy to understand.
Disadvantages, as I mentioned alittle bit previously, is that
it may be hard to findbusinesses similar to yours.
There's a lot of people thathave industries that are very
unique, so it's hard to find acomparable business in a lot of
(04:11):
cases and so market conditionscan fluctuate a lot as well.
So you may not get a lot ofrecent sales.
You have to go back severalyears and market conditions
could have changed over thoseyears.
So that's a little bit of adisadvantage.
I'd say you probably would usethe market approach when you
have those comparable sales.
So if you had a good amount ofcomparable sales you would
probably choose the marketapproach, but oftentimes that
(04:33):
may not be available.
So the income approach focuseson future cash flows.
It can consider your growthpotential, which the other
models will not.
Capitalization of earnings youwould use if you had a company
that had stable historicalearnings, so a company that's
been around a long time.
Their earnings are prettystable over the years you might
use a capitalization of earningsmethod.
(04:54):
The negatives here on that sideare that you're using some
assumptions, especially in adiscounted cash flows method
where you're projecting futureearnings how good are those
projections?
And the reader has to kind ofdetermine if those seem
reasonable or not.
So that can be a disadvantage.
And on the asset side it'spretty straightforward.
So that's an advantage of justlooking at the assets and what
the value of those differentassets are.
(05:14):
Disadvantages could be that itcould ignore intangible assets
or undervalue a business'sintellectual property or whatnot
.
So those could be somepotential disadvantages.
You might use this one if youhave substantial fixed assets
such as a building or a lot ofmachinery or something like.
That might be an instance whereyou might use the asset one.
(05:36):
Or if you have a company that'smaybe newer or has negative
earnings for whatever reason,you may flip over to the asset
approach.
I mean bottom line is is thebusiness is at least going to
sell for whatever it could sellall its assets for?
So you kind of have that as abase.
Speaker 2 (05:51):
And so, tim, what role do financial statements
play in a business valuation?
Speaker 3 (05:58):
Yeah, financial statements play a crucial role
when you're analyzing a business.
So for one, you're going toassess the profitability of the
company.
So a profit and loss statementis going to show your revenue
and expenses and net income andyou're going to use those to
compare against their industryand see how they stack up
against their industry.
You will also use it to seesome different trends that may
(06:20):
be going on inside the business.
If you look at the balancesheet, it's a way to assess the
assets and liabilities, comparethat to the industry and how
some of those things stack up.
You'll also do some financialratio analysis using those
financials.
So, again comparing, looking attrends inside of it.
You know how profitable are you, how liquid are you, how
(06:40):
solvent are you Are alldifferent types, types of some
of the different types offinancial ratios you may look at
to determine the health of acompany and that helps you know
all of these are differentpieces and what help you kind of
assess what the value might be.
Speaker 2 (06:55):
So let's get into some of the other factors that
may play an important role inthe business valuation process.
What are some of those factors?
Speaker 3 (07:06):
The industry is an important part of it.
As I mentioned, you'recomparing a lot of things to the
industry.
High growth industries canoften command higher valuations.
Just similar again to a homeHomes in certain areas are going
to have a different value thanin other areas and businesses
are no different.
So businesses in differentindustries could potentially
have a higher value than others.
Market conditions in theindustry make a difference.
(07:28):
So when you're doing a businessvaluation, you are going to
look at the economy and thenational economy, the local
economy.
How is the economy going toimpact this particular business
and its industry?
How is their local economygoing to impact this business in
this industry?
If you have high unemploymentin your area, that could be a
negative effect on your businessthat may not affect other
businesses or other industries.
So all of those types of thingsthe competition, the level of
(07:52):
competition affects it.
How many competitors do youhave in your industry or in your
market?
All of those are importantparts of the industry and how it
plays a role.
Some other factors that alsoplay a role.
Your management team is goingto be a big part of it.
Having an experienced andcapable management team is going
to help increase the value ofyour business.
It makes for a more stablecompany.
(08:14):
Who's going to be left to runthe business if the owner sells?
Is there management behind thatcan help with those types of
things.
Customer base is also anotherfactor.
Having a loyal and diversecustomer base can increase your
stability and growth prospects.
You don't want to be tooreliant on one customer
necessarily.
That can be a negative.
If you were to lose thatcustomer all of a sudden, what
(08:35):
would you do?
So brand and reputation.
So having a strong brand andrecognition and reputation can
influence.
So that could be brand andreputation.
So having a strong brand andrecognition and reputation can
influence.
So you know that could bepositive and negative.
If the recognition of brand isjust that one owner and that
owner is gone, do you lose someof that?
Those are things that we'lllook at as well.
Speaker 2 (08:52):
Okay, and what about some of the common mistakes
business owners make whenvaluing their business?
Speaker 3 (09:00):
Yeah, some common mistakes that business owners
can make is overestimating theirvalue you know, emotional
attachment can cause you tothink that your business is
worth more than maybe it is andignoring market conditions.
So you know, you might thinkyour business was worth
something years ago, but themarket has changed since then.
So failing to consider thecurrent market conditions and
comparable sales and whatnot canbe a mistake.
(09:21):
Neglecting intangible assets sooverlooking the value of
intangible assets like brand andintellectual property, and lack
of documentation can be anissue, so insufficient financial
records, those types of thingscan lead to an inaccurate
valuation.
Speaker 2 (09:39):
What about?
How can business ownersincrease the value of their
business?
Speaker 3 (09:44):
Sure, yeah, I'd say the number one way business
owners can increase the value oftheir business is to plan ahead
.
I think that's the one bigfailure that a lot make is
there's things you might need todo years in advance to start
building that story of what yourbusiness is worth.
You can increase your financialposition, revenue and
profitability.
You can enhance that managementthat we talked about by trying
(10:04):
to build a stronger team aroundyou to have, you know,
strengthening that brand andthat reputation that we talked
about diversifying revenuestreams, as we talked about not
being reliant on just onecustomer necessarily and just
trying to optimize youroperations to make sure you're
more efficient and whatnot.
Speaker 2 (10:20):
Any final tips for someone who thinks they may need
a business valuation?
Speaker 3 (10:25):
Yeah, final tips for someone that might need a
business valuation definitelyseek professional help.
There's attorneys, cpas andthen, obviously, business
valuators who you're going towant to help you through this
process.
Keep your records updated.
When somebody comes in to maybepotentially purchase your
business, they're going to bedigging through your records
updated.
When somebody comes in to maybepotentially purchase your
business, they're going to bedigging through your records and
you want to make sure you havesolid records.
Understand the purpose so youknow the purpose of a business
(10:47):
valuation is a key driver andhow you come up with a valuation
.
You know what a business isworth in a gift tax situation is
not the same as what a businessmight be worth in a sale
situation.
So just understanding thedifferences between those and
then, finally, just be realistic.
Set realistic expectations.
Be prepared for potentialadjustments based on market
conditions and other factors.
Speaker 2 (11:09):
Love it, Tim.
We'll catch you in the nextepisode.
Have a fantastic rest of yourday.
Speaker 1 (11:14):
Thanks, you too thanks for listening to the
knowing what counts podcast.
Ready to optimize your wealthand protect your future, visit
the mpgroupcpacom or call413-739-1800 to connect with our
(11:37):
team of experts.
Remember, success is aboutknowing what counts.
Welcome to the Knowing what Counts podcast, the
place where expert guidancemeets smart financial decisions.
Whether you're a high net worthindividual or a thriving
business, the experts at MPCPAsare here to help you protect and
optimize your wealth.
Let's get started, becausesuccess begins with knowing what
(00:25):
counts.
Speaker 2 (00:33):
How much is your business really worth?
Partner Tim Provost breaks downthe methods and key factors
that determine a company's value, helping you understand the big
picture behind the numbers.
Welcome back everyone.
I'm Sophia Yvette, co-host,slash producer, back in the
studio with Tim Provost, partnerat MPCPAs.
(00:54):
So, tim, how's it going?
Speaker 3 (00:57):
Good Sophia, how are you?
Speaker 2 (00:59):
I'm doing good.
So, tim, what is a businessvaluation and why is it so
important?
Speaker 3 (01:07):
Business valuations are important for a lot of
different reasons.
A lot of companies might use itto make investment decisions.
So if you're trying to securefunding, investors may want a
valuation to make informeddecisions about buying, selling
or holding an interest in thatbusiness.
You also commonly will seemergers, acquisitions and sales
business.
You also commonly will seemergers, acquisitions and sales.
(01:27):
Accurate valuations areessential for negotiations and a
starting point sometimes as tohow much you may buy or sell a
business.
Also, businesses may use it forstrategic planning.
So you know what ways can weincrease profitability?
Where are some of ourweaknesses?
Internal discussions such asthat.
You'll also commonly see it usedfor succession planning.
So you know adding new ownersto replace an existing owner.
(01:49):
You know passing on to yourfamily or whatnot, you're going
to want to know what thatbusiness is worth and what a
fair value might be for it.
Taxes is another great reasonfor estate or gift taxes.
You may need to get a businessvaluation to determine a
business's worth upon passing orif you wanted to gift ownership
to family or whatnot.
And then legal matters isanother common one.
(02:10):
You might have some legaldisputes divorce settlements,
shareholder disagreements,things like that that may come
into play where a businessvaluation is going to be
required to kind of settle thedispute.
Speaker 2 (02:21):
And so, tim, why don't you introduce yourself to
the audience a little bit?
Speaker 3 (02:26):
Yeah, I'm a partner here at the firm.
I do taxes working with highnet worth individuals, but I
also do business valuations here, so you know it gives us a lot
of different types of servicesthat we offer.
Speaker 2 (02:40):
What are the different methods used in a
business valuation?
You mind sharing that with theaudience?
Sure, yeah, there's threedifferent methods used in a
business valuation.
Speaker 3 (02:46):
You mind sharing that with the audience?
Sure, yeah.
There's three different methodsused in a business valuation,
three main ones.
You have what's called a marketapproach, similar to when you
sell your home.
You go out into comparableswith a real estate agent.
You're going to comparebusinesses to other businesses
within your industry that havebeen sold over the last five, 10
years or whatnot.
You might search severaldifferent databases to come up
with different sales.
That can be tricky to find,sometimes depending on your
(03:08):
industry, but that is one of themain approaches.
Income approach is another onethat's estimating the value of
your business based on yourability to generate future
income.
There's a lot of different submethods underneath that.
Two common ones would be adiscounted cash flow, which is
an analysis using futureearnings, and you also have a
capitalization of earningsmethod, which is looking
(03:29):
historically at your earnings.
And then, finally, you havewhat's called an asset-based
approach, that is, valuatingbased on your assets and your
liabilities, just looking at thebalance sheet.
Speaker 2 (03:40):
What about the advantages and disadvantages of
each method in a businessvaluation, and when would you
use one over the other?
Speaker 3 (03:49):
Sure, the market approach.
The advantages it's easy tounderstand.
I think a lot of people arefamiliar with buying houses and
understand that you brought intocomps and similar comparisons,
so it's easy to understand.
Disadvantages, as I mentioned alittle bit previously, is that
it may be hard to findbusinesses similar to yours.
There's a lot of people thathave industries that are very
unique, so it's hard to find acomparable business in a lot of
(04:11):
cases and so market conditionscan fluctuate a lot as well.
So you may not get a lot ofrecent sales.
You have to go back severalyears and market conditions
could have changed over thoseyears.
So that's a little bit of adisadvantage.
I'd say you probably would usethe market approach when you
have those comparable sales.
So if you had a good amount ofcomparable sales you would
probably choose the marketapproach, but oftentimes that
(04:33):
may not be available.
So the income approach focuseson future cash flows.
It can consider your growthpotential, which the other
models will not.
Capitalization of earnings youwould use if you had a company
that had stable historicalearnings, so a company that's
been around a long time.
Their earnings are prettystable over the years you might
use a capitalization of earningsmethod.
(04:54):
The negatives here on that sideare that you're using some
assumptions, especially in adiscounted cash flows method
where you're projecting futureearnings how good are those
projections?
And the reader has to kind ofdetermine if those seem
reasonable or not.
So that can be a disadvantage.
And on the asset side it'spretty straightforward.
So that's an advantage of justlooking at the assets and what
the value of those differentassets are.
(05:14):
Disadvantages could be that itcould ignore intangible assets
or undervalue a business'sintellectual property or whatnot
.
So those could be somepotential disadvantages.
You might use this one if youhave substantial fixed assets
such as a building or a lot ofmachinery or something like.
That might be an instance whereyou might use the asset one.
(05:36):
Or if you have a company that'smaybe newer or has negative
earnings for whatever reason,you may flip over to the asset
approach.
I mean bottom line is is thebusiness is at least going to
sell for whatever it could sellall its assets for?
So you kind of have that as abase.
Speaker 2 (05:51):
And so, tim, what role do financial statements
play in a business valuation?
Speaker 3 (05:58):
Yeah, financial statements play a crucial role
when you're analyzing a business.
So for one, you're going toassess the profitability of the
company.
So a profit and loss statementis going to show your revenue
and expenses and net income andyou're going to use those to
compare against their industryand see how they stack up
against their industry.
You will also use it to seesome different trends that may
(06:20):
be going on inside the business.
If you look at the balancesheet, it's a way to assess the
assets and liabilities, comparethat to the industry and how
some of those things stack up.
You'll also do some financialratio analysis using those
financials.
So, again comparing, looking attrends inside of it.
You know how profitable are you, how liquid are you, how
(06:40):
solvent are you Are alldifferent types, types of some
of the different types offinancial ratios you may look at
to determine the health of acompany and that helps you know
all of these are differentpieces and what help you kind of
assess what the value might be.
Speaker 2 (06:55):
So let's get into some of the other factors that
may play an important role inthe business valuation process.
What are some of those factors?
Speaker 3 (07:06):
The industry is an important part of it.
As I mentioned, you'recomparing a lot of things to the
industry.
High growth industries canoften command higher valuations.
Just similar again to a homeHomes in certain areas are going
to have a different value thanin other areas and businesses
are no different.
So businesses in differentindustries could potentially
have a higher value than others.
Market conditions in theindustry make a difference.
(07:28):
So when you're doing a businessvaluation, you are going to
look at the economy and thenational economy, the local
economy.
How is the economy going toimpact this particular business
and its industry?
How is their local economygoing to impact this business in
this industry?
If you have high unemploymentin your area, that could be a
negative effect on your businessthat may not affect other
businesses or other industries.
So all of those types of thingsthe competition, the level of
(07:52):
competition affects it.
How many competitors do youhave in your industry or in your
market?
All of those are importantparts of the industry and how it
plays a role.
Some other factors that alsoplay a role.
Your management team is goingto be a big part of it.
Having an experienced andcapable management team is going
to help increase the value ofyour business.
It makes for a more stablecompany.
(08:14):
Who's going to be left to runthe business if the owner sells?
Is there management behind thatcan help with those types of
things.
Customer base is also anotherfactor.
Having a loyal and diversecustomer base can increase your
stability and growth prospects.
You don't want to be tooreliant on one customer
necessarily.
That can be a negative.
If you were to lose thatcustomer all of a sudden, what
(08:35):
would you do?
So brand and reputation.
So having a strong brand andrecognition and reputation can
influence.
So that could be brand andreputation.
So having a strong brand andrecognition and reputation can
influence.
So you know that could bepositive and negative.
If the recognition of brand isjust that one owner and that
owner is gone, do you lose someof that?
Those are things that we'lllook at as well.
Speaker 2 (08:52):
Okay, and what about some of the common mistakes
business owners make whenvaluing their business?
Speaker 3 (09:00):
Yeah, some common mistakes that business owners
can make is overestimating theirvalue you know, emotional
attachment can cause you tothink that your business is
worth more than maybe it is andignoring market conditions.
So you know, you might thinkyour business was worth
something years ago, but themarket has changed since then.
So failing to consider thecurrent market conditions and
comparable sales and whatnot canbe a mistake.
(09:21):
Neglecting intangible assets sooverlooking the value of
intangible assets like brand andintellectual property, and lack
of documentation can be anissue, so insufficient financial
records, those types of thingscan lead to an inaccurate
valuation.
Speaker 2 (09:39):
What about?
How can business ownersincrease the value of their
business?
Speaker 3 (09:44):
Sure, yeah, I'd say the number one way business
owners can increase the value oftheir business is to plan ahead
.
I think that's the one bigfailure that a lot make is
there's things you might need todo years in advance to start
building that story of what yourbusiness is worth.
You can increase your financialposition, revenue and
profitability.
You can enhance that managementthat we talked about by trying
(10:04):
to build a stronger team aroundyou to have, you know,
strengthening that brand andthat reputation that we talked
about diversifying revenuestreams, as we talked about not
being reliant on just onecustomer necessarily and just
trying to optimize youroperations to make sure you're
more efficient and whatnot.
Speaker 2 (10:20):
Any final tips for someone who thinks they may need
a business valuation?
Speaker 3 (10:25):
Yeah, final tips for someone that might need a
business valuation definitelyseek professional help.
There's attorneys, cpas andthen, obviously, business
valuators who you're going towant to help you through this
process.
Keep your records updated.
When somebody comes in to maybepotentially purchase your
business, they're going to bedigging through your records
updated.
When somebody comes in to maybepotentially purchase your
business, they're going to bedigging through your records and
you want to make sure you havesolid records.
Understand the purpose so youknow the purpose of a business
(10:47):
valuation is a key driver andhow you come up with a valuation
.
You know what a business isworth in a gift tax situation is
not the same as what a businessmight be worth in a sale
situation.
So just understanding thedifferences between those and
then, finally, just be realistic.
Set realistic expectations.
Be prepared for potentialadjustments based on market
conditions and other factors.
Speaker 2 (11:09):
Love it, Tim.
We'll catch you in the nextepisode.
Have a fantastic rest of yourday.
Speaker 1 (11:14):
Thanks, you too thanks for listening to the
knowing what counts podcast.
Ready to optimize your wealthand protect your future, visit
the mpgroupcpacom or call413-739-1800 to connect with our
(11:37):
team of experts.
Remember, success is aboutknowing what counts.
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