Real Value
The real value of the practice is determined by the buyer and seller through their negotiations.
The more “experts” you ask, the more opinions you will receive. And more than likely, the opinions will vary widely. There are many instances when the value of business assets is needed, such as for buy-sell agreements, business loans, and for estate planning purposes. At your death, the value of your estate is subject to estate taxes. Your business assets are part of your estate. Therefore, the higher the value of your business in your estate, the more estate taxes you will pay. The lower the value of your business, the less estate tax you will pay. The irs will attempt to value your business at the highest reasonable level, while your heirs will try to minimize the value of your business.
Methods of Value
There are many methods by which a business may be valued. Five of the most commonly used methods are described below.
Book Value:
The value at which the business is carried on a balance sheet, with all assets. Adjusted for fair market value (fair market value may not be the same as the depreciated value for income purposes).
Straight Capitalization Method:
The amount of capital that would have to be invested at a specified rate to yield the current average net annual earnings of the business.
Capitalization of Earnings Method:
Assumes that part of earnings are attributed to the assets of the business (book value). Remaining earnings are capitalized at a rate consistent with the relative risk of the business. The result is then added to book value.
Years’ Purchase Method:
A conservative rate (the pure money rate for an investment with generally accepted lower risk) is used to determine the earnings attributed to assets. The balance is assumed to be provided by goodwill. The earnings provided by goodwill are then multiplied by the number of years for which goodwill is expected to be valuable to a purchaser. The result is then added to the book value to obtain the valuation.
Discounted Future Earnings Method:
Projected future business earnings are forecasted, and then discounted using an appropriate rate which reflects the return from the next best investment opportunity with a comparable level of risk. The sum of the discounted future earnings is the current valuation.
Note: the average of these five methods is not an acceptable method of valuation. It is shown in this presentation for comparison purposes only. Each business should have a practice professional appraiser determine the method that will best represent all of its factors.
