Business valuation reports are the benchmark for determining how much an organisation is worth at any given time. They’re commissioned to facilitate business purchases but also provide value internally for charting your journey.
In the past year, entrepreneurs made £11.8 billion selling their firms, even though total sales figures were down. Determining what is or isn’t a good deal isn’t a matter of guesswork but relying on a specific scientific method.
Let’s discuss what you can expect in a valuation report and how to make sense of one.
Do you need a professional to read a business valuation report?
Business valuation reports are always prepared by specialists in their field. As formal written reports, entrepreneurs often make the mistake of assuming that they also need a professional to make sense of their numbers.
Although professional advice enables one to gain more from a report, any competent businessperson can understand precisely what a report entails. That includes even just looking at the base value.
What you’re likely to see in a business valuation report
Business valuation reports rely on data extracted from the company being valued, knowledge of the competition, and information on the market in which a company operates.
Every report follows a similar structure, but they all provide similar information, including:
· Summary and background of the company.
· What the company does, with information on its products and services.
· Financial analysis of the company.
· Competitive analysis, looking at other firms.
· Market analysis, which discusses the overall industry.
· Which valuation method was used.
· How the company operates.
· The final valuation and how the valuation expert came to that number.
Different valuation experts may format their reports in a way they prefer, but the information in a comprehensive report will always be the same. In most cases, you’ll also be able to ask questions of the person who put the report together if there’s anything you don’t understand or if you need additional clarification.
How to read a business valuation report
Business valuation reports aim to provide as much of an objective view of the value of an organisation as possible. If you’re examining a valuation report for the first time, here are the aspects to focus on.
Final valuation
Your first port of call is to examine the valuation. Alongside being included in the conclusion of the report, this figure will be displayed on one of the first pages. If you already had a rough figure in mind, this is the time to determine whether you were in the same region as the final valuation.
Company background & operations
Entrepreneurs seeking to purchase a business should take the time to re-examine the company’s background and its current operations. Does what is presented in this report align with your expectations?
When you are in the market for a business acquisition, it’s easy to make assumptions. The initial company background description, including major stakeholders, will clarify what you think you know. Later in the report, there will be more information on how it operates and how this has contributed to the final valuation.
Valuation Methodology
The valuation methodology is perhaps the most important part of the report because this is the pivot that determines the value. Using one methodology over another dramatically changes the final result. Any good business valuation report will also include the reasoning behind the valuation expert’s decision to use one methodology over another.
If multiples are part of the methodology, pay attention to which multiples were used and whether they are appropriate. Since the peak of 2020-21, deal sizes have fallen dramatically due to changing multiples used in valuation methodologies.
Remember, in many cases, the correct methodology varies based on whether you are buying or selling a business. The buyer wants the lowest value possible and vice-versa.
Understanding the appraiser’s logic
Every business valuation can be challenged because a significant amount of professional judgement is involved.
For example, you may question a comparison between recently sold businesses by arguing that no two businesses are the same. That is the inherent weakness if your report is using the market-based approach.
Likewise, if your report relies on earnings forecasts, these can be questioned because it’s easy to edge into too-optimistic vs. too-pessimistic territory. Generally, professionally prepared reports fall into a narrow range, but it’s your right to cast doubt on the result.
It’s these issues that require a firm understanding of the valuation agent’s logic. Within your report, you should see the justification for why the expert used one option over another. Do you agree with that logic? Are there any flaws in this logic?
Business valuation isn’t an exact science, which is why it’s wise to take your time in reading these sections, rather than taking the final figure at face value.
Normalising entries
Normalising adjustments are often contained within the narrative sections of the report, which many entrepreneurs tend to skip over to get straight to the numbers.
These adjustments only happen every so often and are usually one-time events.
Examples could include:
· Natural disasters
· Sale of an asset
· Downsizing/expansion
Normalising adjustments can have a considerable impact on the final business valuation. For example, if adjustments have been made for significant experts, they may not have been included at the current market rate.
There’s nothing wrong with factoring in normalising adjustments into a report, but it’s critical that you agree with them. Likewise, search for any potential adjustments that weren’t included and ask why.
Business valuation summary
Typically, you’ll see the total value of a business plus any additions or subtractions for any items on the balance sheet that increase or decrease its value. These are the things that your business doesn’t necessarily require to operate.
Read this section carefully to check for non-operating assets and liabilities. Have they been included correctly? For example, you may have unused land on the balance sheet or excess cash in your bank account that hasn’t been listed.
Plus, there may be a discount applied to some of these items. Popular subtractions include a lack of control and a lack of marketability. Again, this is where you need justification and the chance to question whether the discount is appropriate.
Making the most of your business valuation report
Never look at the pound figure provided and accept it at face value. Take the time to read through every section of the report. Above all, ensure that everything relevant has been listed and the appraiser’s logic behind why they did what they did.
Many businesses looking to buy or sell may commission multiple independent reports to get a narrower range of estimates. At Hilton Smythe, we can connect you with independent business valuation experts to equip you with all the information you need to get an accurate and objective report. To learn more, contact us now.