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What is Business Valuation?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 31 October 2016
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Business valuation is a strategy that is used to assess the essential or intrinsic value of a business, or the owner’s interest in that business. This strategy is employed in a number of different applications, including estimating taxes due on the operation, identifying an equitable selling price for the business, and a number of other purposes required by law. The process of valuation will look closely at the current worth of the assets held, the general economic conditions that could have an effect on the value of the operation in general, and the amount of the owner’s interest or investment in the business enterprise itself.

In beginning to prepare a business valuation, one of the first factors to consider is the impact of the economic conditions that apply in the area where the business operates. Along with looking closely at the state of the local economy, it is also helpful to consider the economic conditions that prevail in the wider region around the local area, as well as the national economy. Often, current statistics can be obtained from local, regional, and national agencies that monitor economic activity closely. This data can be related to the output and the sales generation of the business, and thus have an idea of how those economic factors are impacting the business.

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Along with assessing the state of the economy and its impact on the business, a business valuation will also look closely at factors related to the industry that the company is involved in. Here, the focus is on identifying trends within the industry that are likely to affect the business, either in a positive or negative manner. Factors like the general profitability of the industry, shifts in technology, and the rate of turnover among the major players in the industry will also be considered. All this data is then related back to the business under scrutiny, and its current level of operation.

The internal workings of the business is also of interest when conducting a business valuation. Reviewing the financial records, and comparing different periods can aid in developing a good idea of whether the company is making gains consistently, is somewhat stagnant when it comes to sales, or is beginning to lose a portion of its market share. This helps to identify the degree of risk associated with continuing to hold an interest in the business, as well as the risk involved when it comes to investing in the company.

While a business valuation is often conducted to ascertain the status of an individual company, the same approach is applied when looking at the amount of investment that the owner currently holds within a business. This is often necessary when someone is interested in buying out the current owner, or when a legal issue such as divorce is in progress, and there is a need to divide the assets as part of the divorce action. By assessing the fair market value of that involvement, it is much easier to determine the most equitable split in terms of the assets. In areas where community property laws must be considered as part of the divorce settlement, a business valuation can simplify the assignment of the ownership to one or both parties involved in the divorce, or order the sale of the interest and divide the proceeds among the two parties.

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Disputes often arise when a business valuation is done for a company in bankruptcy.

A valuation is frequently used in bankruptcy cases to determine the level of recovery creditors can expect in the event of a sale or investment in a reorganized company.

In most cases, the bankrupt company and investors or buyers will benefit from a lower enterprise value. If the value is lower than the debt owed to creditors, the company can claim it is out of the money and promise fewer distributions.

As a result, the company and one or two creditor or shareholder groups may commission separate valuations, leaving the court to ultimately decide the value or range of value of the company.

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