Upgrade to remove ads
Only $35.99/year

Florida Real Estate Broker Chapter 9 - Basic Business Appraisal

Terms in this set (62)

A business appraisal can help an owner determine if he is getting the correct sum of
compensation from the govern-ment taking the property through
condemnation proceedings
Even with general accounting principles, it is possible to run into a series of problems with
the accounting systems. Some of these problems include
a. Differences in accounting methods
b. Missing assets and liabilities
c. Valuation accounts do not reflect value
A business appraisal is called for when the business is to be
sold, business ownership interest is gifted or transferred as part of an estate, addition or departure of business partners, legal separation of business owners, or for business financing purposes.
Typical business appraisal recipients are
business owners and buyers, commercial lenders, investors, tax authorities, legal professionals, and courts.
Which approach is usually appropriate for a sole proprietorship, especially if the subject business is well established and thriving.
The Income Approach
Reasons for a Business Appraisal
1. Contemplated Sale or Purchase of a Business
2. Allocation of Value to Specific Assets
3. Financial Reporting Purposes
4. Buy-sell Agreements
5. Liquidation of a Business
6. Divorce
7. Estate and Inheritance Taxation
8. Condemnation Proceedings
9. Employee Benefits Plans
10. Determination of Insurable Value
Allocation of value to specific assets is done when
only a portion of the business is for sale.
There are six steps in valuing a business:
1. Definition of the Assignment
2. Establish the Date of the Appraisal
3. Data Collection
4. Analysis of Data
5. Determine Final Estimate of Value
6. Preparation of the appraisal report
A business valuation report should contain the following information
• Summary of facts and conclusion
• Purpose of the valuation report (e.g., market value) • Define the value estimated
• Description of the business appraised and process used
• The effective date of the value estimate
• Summary of facts (based on collected data)
• Statement of conclusions reached
• Assumptions and limiting conditions
• Supporting data (maps, exhibits, etc.)
Financial statements are
• Income tax statements
• Income and expense sheets; • Current inventory lists
; • A current list of liabilities and assets;
• Current information on bank loans;
• Current information on payroll expenses.
Even with general accounting principles, it is possible to run into a series of problems with the accounting systems. Here are some of the more notable problems:
1. Estimates are Necessary
2. Assets are Reported at Cost
3. Valuation Accounts do not Reflect Value
4. Assets and Liabilities may be Missing
5. Differences in Accounting Methods are Permitted
One obvious problem associated with Generally Accepted Accounting Principles is that real income and reported income will be different. Several steps should be taken to ensure that the data used accurately reflect the real economic condition of the business.
1. Construct Historical Series
2. Calculate Financial Ratios Over Time
3. Investigate Unusual Items and Results
The initial step in analyzing financial statements is to develop
a historical financial statement. This will involve collecting balance sheets and income statements for the past three to five years. Income tax returns may also be useful, particularly for smaller business opportunities.
The second step in analyzing financial statements
will be to apply various financial ratios to the data that was obtained during the initial step.
The following are ratios that should be considered when analyzing a business's financial position:
a. Quick Ratio
b. Inventory Turnover
c. Debt-to-Worth ratio
d. Net Profit- to- Owner
The quick ratio compares a
business's current assets to current liabilities
The quick ratio is sometimes known as the
"acid test
Quick Ratio =
Current Assets - Inventories / Current Liabilities
Current Ratio =
Current Assets / Current Liabilities
used to determine how quickly inventories move through the company.
The inventory turnover ratio
The inventory turnover ratio is calculated
by dividing the cost of goods sold by the ending inventories.
provides a quick measure of total indebtedness relative to the value of the equity position of the owners
The debt-to worth ratio
The debt-to worth ratio is calculated
by dividing total liabilities by the net
worth of the business
The net profit to owner ratio is
computed by dividing the before-tax cash flow by the tangible net worth of the business.
Net Profit to Owner Ratio =
Net profit before taxes / Tangible Net Worth
The final step in analyzing financial statements is to investigate
unusual items that were discovered when working the various financial ratios.
The analysis of data collected will assist the business broker in developing an
adjusted balance sheet, a market balance sheet, an adjusted income statement, and a pro forma income statement
An adjusted balance sheet excludes items such as
intangible assets, assets that are outside normal business operations, and other items that might give a false interpretation of the financial condition of the business.
A market balance sheet restates the owner's
equity position as it relates to tangible assets at market value.
Items that are typically adjusted for the market balance sheet include
. accounts receivable which readjust bad debt more accurately, 2. inventory at market value, 3. equipment and machinery at market value, not book value.
The adjusted income statement is structured to eliminate
all items that may distort or skew the true financial position of the business.
The pro forma income statement projects future
cash flows based on current and historical data of the business.
This is considered the most important statement used in estimating a business's value based on income.
Pro Forma Income Statement
Approaches to Business Valuation
1. The Sales Comparison Approach
2. The Cost-depreciation Approach
3. The Income Capitalization Approach
4. The Liquidation Value Approach
The cost depreciation approach to valuing a business is somewhat
unreliable due to the flexibility of sales over the years, and the value is more dependent on sales than on assets.
Using The Income Capitalization Approach After obtaining the net income
divide the income by the cap rate to determine the market value of the business.
This business valuation approach is used when the company is determined to no longer be a going concern and liquidating the assets would yield a higher value than the present value of its future earnings and
cash flow potential.
The Liquidation Value Approach
Intangible assets (intangibles) are
long-lived assets used in the production of goods and services. They lack physical properties and represent legal rights or competitive advantages (a bundle of rights) developed or acquired by an owner
goodwill is defined as
"the excess of the cost of an acquired entity over the net amounts assigned to assets acquired and liabilities assumed
To determine goodwill in a simplistic formula, take
the purchase price of a company and subtract the net fair market value of identifiable assets and liabilities.
Business goodwill represents the value
of the reputation of a business. This value is a combination of consumer satisfaction, marketing accomplishments, and expected growth.
Personal goodwill represents the value of the reputation
of the owner or employees of a business. Personalities and special talents can hold a value that is difficult to determine
separable intangible assets include
licenses, trademarks, copyrights, and franchises.
The appraiser has two choices of business valuation of intangible assets
Excess Profits Approach and the Market Residual Approach.
In the excess profits approach; goodwill is defined as
the difference between the combined company's profit over normal earnings for a similar business
To calculate goodwill using the excess profit approach an appraiser would
estimate the value of the company's net tangible assets, then multiply that value by a fair rate of return to calculate earnings attributable to the company's tangible assets. Next, the appraiser needs to estimate the company's total normalized earnings, then subtract earnings on tangible assets from total earnings to arrive at excess earnings. This
represents the company's earnings above the return on the company's net tangible asset
value. The next step would then be to divide the excess earnings by an appropriate
capitalization rate to calculate the value of goodwill and other intangible assets. The
capitalization rate may be subjective or obtained from market indices. Once the
appraiser has obtained both amounts, they would be added together to arrive at the
company's valuation.
The Market Residual Approach
First values the tangible assets, and then subtracts this value from the total value of the
business. This equals the value of the intangible assets. The appraiser then estimates
the value of each separate intangible asset, by dividing each specific asset's generated
net income by the capitalization rate. Goodwill value is anything left after the value of
the tangible and intangible assets is found
The formula for calculating the net profit to- the owner ratio is:
d. Net profit before taxes ÷ tangible net worth
The adjusted income statement is structured in order to
b. eliminate all items that may distort or skew the true financial position of the business
When the value of the business is calculated into the estate of the deceased as the basis for
inher-itance taxation, how is the business valued?
The valuation would be based on a fair market value of the business at the time of the person's
death.
An adjusted balance sheet excludes
intangible assets, assets that are outside normal business operations
The formula for calculating quick ratio is:
Current assets - inventory ÷ current liabilities
In order for a business broker to become familiar with the business that is being valued, the
broker would source which type of data?
primary data
Which ratio is used to determine if a company has the ability to meet its current obligations
without considering its inventory worth?
Quick ratio
Which of the following approaches to a business's value estimates the value of each asset of
the business then pays off all liabilities?
d. Liquidation value approach
A business valuation report should contain the following information
b. Summary of facts
c. Define the value estimated
d. Assumption and limiting conditions
Which business entity benefits from a tax advantage that means the principals pay tax, and
not the legal business entity?
Partnerships
Which of the following is/are problem(s) an appraiser may face when providing a valuation
for a business?
a. Some items may need to be estimated because it may not be the proper time to pay these
expenses
b. Assets may not be accounted for at the current market value
c. The business may be very liberal in estimating the economic life of their assets
Which financial report would be used for a final conclusion of a company's value:
market and adjusted balance sheet.
b. adjusted income statement, and a pro forma income statement.
Which approaches determine the value of tangible assets?
a. The excess profits approach
b. The market residual approach
A communication company has a cell phone division for sale. The appraiser would
specifically value the cell phone division in comparison with the value of the entire company.
The owner of the business is aware of how much each part of the business is worth, by doing
allocation of value
Which of the following steps below should be used in analyzing financial statements, which
in-cludes collecting balance sheets and income statements for the past three to five years?
Construct a historical series
Sets found in the same folder