594 Making Key Strategic Decisions
would be determined. Bob asked his certified public accountant (CPA) about
valuing the business. The CPA tells him that it would be most appropriate to
engage someone who specializes in business valuations. After interviewing sev-
eral candidates, Bob hires Victoria to appraise his business. The valuation date
is December 31, 2000, and the standard of value is fair market value. Victoria
explains the appraisal process and the scope of her work.
THREE APPROACHES TO VALUE
Victoria tells Bob that the value of a business is determined by considering
three approaches.
- Income approach.
- Market approach.
- Asset (or cost) approach.
The income approach is a general way of determining the value using a
method to convert anticipated financial benefits, such as cash f lows, into a
present single amount. This approach is based on the concept that the value of
something is its expected future benefits expressed in present value dollars. (A
simple example of present value is that a dollar received a year from now is
worth less than a dollar today.)
The market approach is a general way of determining a value comparing
the asset to similar assets that have been sold. For example, real estate ap-
praisals using the market approach rely on the sales prices of comparable prop-
erties. In business valuation, it is sometimes possible to locate similar businesses
that have sold and are appropriate to use as guidelines in the appraisal.
The asset approach is a general way of determining the value based on the
individual values of the assets of that business less its liabilities. The company’s
balance sheet serves as a starting point for this approach. The proper applica-
tion requires that all of the business’s assets be identified. Often, the balance
sheet prepared in accordance with general accepted accounting principals
does not include assets that have been created within the company such as
goodwill and other intangible assets. Once all the company assets and liabili-
ties have been identified, each one is valued separately.
DIFFERENT TYPES OF BUYERS
Victoria explains to Bob that buyers have different motives for acquiring busi-
nesses and they may be willing to pay different prices for the same business.
Most buyer motives can be grouped into these categories:
- Financial buyers.These buyers are primarily motivated by getting an ap-
propriate rate of return on their investment. Financial buyers generally
have a much broader range of investment alternatives than other types of