How Often Should You Value Your Business?
Business valuation is important for understanding a business’s worth, but determining the right valuation frequency requires careful consideration. A variety of factors influence how often businesses should conduct valuations, including industry dynamics, the company’s growth stage, overall economic conditions, and other specific business circumstances. By exploring these factors, businesses can establish an optimal valuation schedule to maximize value and mitigate risks.
The Importance of Regular Valuations
Investing in annual valuations pays off during succession and exit planning by providing a snapshot of the company’s worth and performance trends over time. These valuations also help identify where the business for improving value through operational efficiencies, strategic investments, or market positioning. Additionally, company valuations offer insights into industry trends and competitive landscapes.
Determining the Right Valuation Frequency
The frequency of business valuation depends on various factors, and the norms vary from industry to industry. Industries with high volatility or rapid technological advancements, such as biotech, might benefit from more frequent valuations. Stable industries, like utilities, often opt for less frequent valuations (even as infrequently as 2-3 years). The business valuation process and timeline vary in part due to a desire to balance cost, relevance, and accuracy.
Quarterly Valuation
- Pros: Frequent updates on business performance makes it easier to monitor trends and performance metrics. Most suitable for fast-changing industries.
- Cons: Higher frequency leads to higher cost. Often thought to be excessive for stable businesses.
Annual Valuations
- Pros: Provides a regular snapshot of business value, often scheduled to align with financial reporting cycles. Useful for long-term strategic planning and exit strategies.
- Cons: May cause a business owner to miss rapid market changes or short-term fluctuations.
Periodic Valuation
- Pros: Balances frequency and cost-effectiveness.
- Cons: May overlook short-term fluctuations and sudden market shifts.
Ad Hoc Valuation
- Pros: Flexible and responsive to specific events or needs.
- Cons: Often seen as reactive rather than proactive and lacks the consistent tracking of business value that many industries need for estate planning.
Choosing a Valuation Method
Businesses usually choose between one of three business valuation methods: Market, Income, and Asset.
- Market Approach: This method assesses the business's value by comparing it to similar recently sold businesses. It relies on market data and transactions in the industry to derive a valuation multiple (such as price-to-earnings ratio). The market approach is effective when there are comparable transactions and publicly available data, making it suitable for businesses with clear market comparables.
- Income Approach: The income approach calculates the value of a business based on its expected future income or cash flow. Common methods include the discounted cash flow (DCF) analysis or capitalization of earnings approach. This method is ideal for businesses with predictable cash flows and steady growth patterns.
- Asset Approach: The asset approach values a business based on its tangible and intangible assets, minus liabilities. This method is especially relevant for asset-heavy businesses, like real estate, where the underlying assets hold significant value. However, it may undervalue businesses with strong intangible assets, like those with substantial intellectual property in brand assets.
Market Impact on Business Valuations
The market significantly impacts business valuations by influencing investor perceptions of risk and return. Changes in market conditions, such as shifts in interest rates, industry trends, or economic stability, can directly affect the perceived value of a business.
In bullish markets, business valuations tend to be higher due to increased demand and optimism. Conversely, during market downturns, valuations may decline as investors anticipate lower future cash flows. Market volatility can also impact financing availability and influence discount rates used in valuation models like the discounted cash flow (DCF) method.
Including Real Estate in Business Valuation
To include real estate valuation as part of a company’s financial valuation:
- Identify Assets: Determine which real estate assets are integral to the business operations.
- Conduct an Appraisal: Hire a qualified real estate appraiser. The appraiser will consider factors such as location, size, condition, and comparable property sales in the area. If the real estate generates rental income, use the income approach to determine the value based on expected future cash flows.
- Adjust for Liabilities: Subtract any outstanding mortgages or liabilities on the balance sheet to determine the net real estate value.
- Factor into Business Valuation: Finally, combine the real estate value with other components of the business valuation to arrive at a comprehensive valuation of the entire business entity.
Tax Considerations in Business Valuations
Choosing appropriate valuation methods is important for IRS compliance, especially for estate and gift tax purposes. Not only can there be tax liabilities associated with transferring ownership or making gifts, but capital gains taxes may apply based on the valuation of appreciated assets.
Additionally, valuations influence corporate tax planning strategies, affecting depreciation deductions, intangible asset amortization, and the utilization of net operating losses. In transactions like mergers or acquisitions, accurate valuations determine the allocation of purchase price to assets, impacting future tax deductions.
The Role of Professionals in Business Valuations
Certified appraisers, business valuation experts, CPAs, and business brokers bring specialized knowledge, experience, and objectivity to the valuation process. These professionals use various methodologies tailored to the specific industry, business size, and purpose of the valuation.
Professionals expertise can reduce errors. With an eye to detail, these partners ensure accurate assessments of tangible and intangible assets, financial performance, market conditions, and risk factors. They can also provide valuable insight into tax implications, financial planning, and strategic decision-making based on the valuation results.
Using BizBuySell for Valuation
Harness a better understanding of your company’s value with BizBuySell. Start by visiting the Valuation Learning Center to navigate forecasting and value drivers for your company. Use tools like the BizWorth calculator and Valuation Report to understand the present fair market value. Whether you’re planning to sell or pursuing a new opportunity, business listings can help make the most of your time and planning.