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Going-concern value is a method of establishing a value, or purchase price, for a business. It assumes that the business will remain a “going concern,” or operational, going forward and takes future earning potential into account. The fact that the business is valued on an operational basis distinguishes this valuation method from using a liquidation value. Liquidation uses the price of tangible assets to establish value and assumes the business will be closing its doors for good after the sale.
There are many reasons a business owner might need to establish the current value of a business. The most common reason is to sell it. Another reason is the need to divide up assets, perhaps after a break-up of a business partnership or in a divorce where the value of marital assets must be determined. Establishing a value for a business is not an exact science, however. There are a number of economic models that estimate value by looking at different indicators, but the two main categories of valuation are going-concern value and liquidation value.
The decision whether to use going-concern or liquidation value depends upon whether the business will remain open or whether it will be closing its doors for good. Liquidation value is an estimate of what the tangible assets would sell for at a fire sale. Typically, the liquidation value is less than the going-concern value because liquidation tends to require a sale on any reasonable terms without the luxury of an unlimited amount of time to find the best sales price.
Comparatively, going-concern value is the worth of the tangible and intangible assets of the business, assuming it remains operational going forward. It includes the liquidation value of the assets but adds to the equation the value of a steady revenue stream over time and the business's intangible assets, such as goodwill and reputation. The going-concern value is more speculative than the liquidation value, as it is impossible to estimate the future growth of a business with certainty.
One of the important concepts that helps establish going-concern value is the notion of present value of future earnings. The valuation model is not a simple multiplication of the business's revenue year after year. Instead, it is a discounted value that establishes the present value of future earnings, or what the worth of those future earnings would be if they were paid out today. The present value as a lump sum is always less than what the value would be over time, because the present value payment removes the ability to compound earnings. It is very similar to the way a lottery pays out winnings, as a sum that is less than the advertised winnings if taken presently all at once or in the advertised amount is taken over time.
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