Knowing What Counts Podcast

Unlocking Business Value: Mastering Valuation Strategies with Tim Provost

• Tim Provost, CPA • Episode 4

Share episode

Send us a text

What Are The Most Effective Methods For Determining A Business's Value?

Learn the secrets of business valuation with Tim Provost, a partner at MP CPAs, as we explore the complex world of determining a company's true worth. Whether you're eyeing investment opportunities or planning strategic moves like mergers and acquisitions, understanding business valuation is critical. Tim guides us through the three primary methods—market, income, and asset-based approaches—shedding light on when and why each is used. We delve into how factors such as comparable sales and growth potential influence these methods, and why accurate financial statements are the cornerstone of any valuation process.

Navigating the nuances of valuation for different scenarios, like gift tax purposes versus a sale, is essential for setting realistic expectations. Tim shares insights on preparing for adjustments due to fluctuating market conditions, helping you optimize wealth and safeguard future financial interests. This episode is packed with practical advice and expert knowledge that promises to enhance your financial strategy toolkit. Tune in for a deep dive into the dynamics of business valuation and learn how to leverage this knowledge to your advantage.

To learn more about MP CPAs visit:
https://thempgroupcpa.com/
MP CPAs
413-739-1800

Speaker 1:

Welcome to the Knowing what Counts podcast, the place where expert guidance meets smart financial decisions. Whether you're a high net worth individual or a thriving business, the experts at MPCPAs are here to help you protect and optimize your wealth. Let's get started, because success begins with knowing what counts.

Speaker 2:

How much is your business really worth? Partner Tim Provost breaks down the methods and key factors that determine a company's value, helping you understand the big picture behind the numbers. Welcome back everyone. I'm Sophia Yvette, co-host, slash producer, back in the studio with Tim Provost, partner at MPCPAs. So, tim, how's it going?

Speaker 3:

Good Sophia, how are you?

Speaker 2:

I'm doing good. So, tim, what is a business valuation and why is it so important?

Speaker 3:

Business valuations are important for a lot of different reasons. A lot of companies might use it to make investment decisions. So if you're trying to secure funding, investors may want a valuation to make informed decisions about buying, selling or holding an interest in that business. You also commonly will see mergers, acquisitions and sales business. You also commonly will see mergers, acquisitions and sales. Accurate valuations are essential for negotiations and a starting point sometimes as to how much you may buy or sell a business. Also, businesses may use it for strategic planning. So you know what ways can we increase profitability? Where are some of our weaknesses? Internal discussions such as that.

Speaker 3:

You'll also commonly see it used for succession planning. So you know adding new owners to replace an existing owner. You know passing on to your family or whatnot, you're going to want to know what that business is worth and what a fair value might be for it. Taxes is another great reason for estate or gift taxes. You may need to get a business valuation to determine a business's worth upon passing or if you wanted to gift ownership to family or whatnot. And then legal matters is another common one. You might have some legal disputes divorce settlements, shareholder disagreements, things like that that may come into play where a business valuation is going to be required to kind of settle the dispute.

Speaker 2:

And so, tim, why don't you introduce yourself to the audience a little bit?

Speaker 3:

Yeah, I'm a partner here at the firm. I do taxes working with high net worth individuals, but I also do business valuations here, so you know it gives us a lot of different types of services that we offer.

Speaker 2:

What are the different methods used in a business valuation? You mind sharing that with the audience? Sure, yeah, there's three different methods used in a business valuation.

Speaker 3:

You mind sharing that with the audience? Sure, yeah. There's three different methods used in a business valuation, three main ones. You have what's called a market approach, similar to when you sell your home. You go out into comparables with a real estate agent. You're going to compare businesses to other businesses within your industry that have been sold over the last five, 10 years or whatnot. You might search several different databases to come up with different sales. That can be tricky to find, sometimes depending on your industry, but that is one of the main approaches. Income approach is another one that's estimating the value of your business based on your ability to generate future income. There's a lot of different sub methods underneath that. Two common ones would be a discounted cash flow, which is an analysis using future earnings, and you also have a capitalization of earnings method, which is looking historically at your earnings. And then, finally, you have what's called an asset-based approach, that is, valuating based on your assets and your liabilities, just looking at the balance sheet.

Speaker 2:

What about the advantages and disadvantages of each method in a business valuation, and when would you use one over the other?

Speaker 3:

Sure, the market approach. The advantages it's easy to understand. I think a lot of people are familiar with buying houses and understand that you brought into comps and similar comparisons, so it's easy to understand. Disadvantages, as I mentioned a little bit previously, is that it may be hard to find businesses similar to yours. There's a lot of people that have industries that are very unique, so it's hard to find a comparable business in a lot of cases and so market conditions can fluctuate a lot as well. So you may not get a lot of recent sales. You have to go back several years and market conditions could have changed over those years. So that's a little bit of a disadvantage. I'd say you probably would use the market approach when you have those comparable sales. So if you had a good amount of comparable sales you would probably choose the market approach, but oftentimes that may not be available.

Speaker 3:

So the income approach focuses on future cash flows. It can consider your growth potential, which the other models will not. Capitalization of earnings you would use if you had a company that had stable historical earnings, so a company that's been around a long time. Their earnings are pretty stable over the years you might use a capitalization of earnings method. The negatives here on that side are that you're using some assumptions, especially in a discounted cash flows method where you're projecting future earnings how good are those projections? And the reader has to kind of determine if those seem reasonable or not. So that can be a disadvantage.

Speaker 3:

And on the asset side it's pretty straightforward. So that's an advantage of just looking at the assets and what the value of those different assets are. Disadvantages could be that it could ignore intangible assets or undervalue a business's intellectual property or whatnot. So those could be some potential disadvantages. You might use this one if you have substantial fixed assets such as a building or a lot of machinery or something like. That might be an instance where you might use the asset one. Or if you have a company that's maybe newer or has negative earnings for whatever reason, you may flip over to the asset approach. I mean bottom line is is the business is at least going to sell for whatever it could sell all its assets for? So you kind of have that as a base.

Speaker 2:

And so, tim, what role do financial statements play in a business valuation?

Speaker 3:

Yeah, financial statements play a crucial role when you're analyzing a business. So for one, you're going to assess the profitability of the company. So a profit and loss statement is going to show your revenue and expenses and net income and you're going to use those to compare against their industry and see how they stack up against their industry. You will also use it to see some different trends that may be going on inside the business. If you look at the balance sheet, it's a way to assess the assets and liabilities, compare that to the industry and how some of those things stack up. You'll also do some financial ratio analysis using those financials. So, again comparing, looking at trends inside of it. You know how profitable are you, how liquid are you, how solvent are you Are all different types, types of some of the different types of financial ratios you may look at to determine the health of a company and that helps you know all of these are different pieces and what help you kind of assess what the value might be.

Speaker 2:

So let's get into some of the other factors that may play an important role in the business valuation process. What are some of those factors?

Speaker 3:

The industry is an important part of it. As I mentioned, you're comparing a lot of things to the industry. High growth industries can often command higher valuations. Just similar again to a home Homes in certain areas are going to have a different value than in other areas and businesses are no different. So businesses in different industries could potentially have a higher value than others. Market conditions in the industry make a difference. So when you're doing a business valuation, you are going to look at the economy and the national economy, the local economy. How is the economy going to impact this particular business and its industry? How is their local economy going to impact this business in this industry? If you have high unemployment in your area, that could be a negative effect on your business that may not affect other businesses or other industries. So all of those types of things the competition, the level of competition affects it. How many competitors do you have in your industry or in your market? All of those are important parts of the industry and how it plays a role.

Speaker 3:

Some other factors that also play a role. Your management team is going to be a big part of it. Having an experienced and capable management team is going to help increase the value of your business. It makes for a more stable company. Who's going to be left to run the business if the owner sells? Is there management behind that can help with those types of things. Customer base is also another factor. Having a loyal and diverse customer base can increase your stability and growth prospects. You don't want to be too reliant on one customer necessarily. That can be a negative. If you were to lose that customer all of a sudden, what would you do? So brand and reputation. So having a strong brand and recognition and reputation can influence. So that could be brand and reputation. So having a strong brand and recognition and reputation can influence. So you know that could be positive and negative. If the recognition of brand is just that one owner and that owner is gone, do you lose some of that? Those are things that we'll look at as well.

Speaker 2:

Okay, and what about some of the common mistakes business owners make when valuing their business?

Speaker 3:

Yeah, some common mistakes that business owners can make is overestimating their value you know, emotional attachment can cause you to think that your business is worth more than maybe it is and ignoring market conditions. So you know, you might think your business was worth something years ago, but the market has changed since then. So failing to consider the current market conditions and comparable sales and whatnot can be a mistake. Neglecting intangible assets so overlooking the value of intangible assets like brand and intellectual property, and lack of documentation can be an issue, so insufficient financial records, those types of things can lead to an inaccurate valuation.

Speaker 2:

What about? How can business owners increase the value of their business?

Speaker 3:

Sure, yeah, I'd say the number one way business owners can increase the value of their business is to plan ahead. I think that's the one big failure that a lot make is there's things you might need to do years in advance to start building that story of what your business is worth. You can increase your financial position, revenue and profitability. You can enhance that management that we talked about by trying to build a stronger team around you to have, you know, strengthening that brand and that reputation that we talked about diversifying revenue streams, as we talked about not being reliant on just one customer necessarily and just trying to optimize your operations to make sure you're more efficient and whatnot.

Speaker 2:

Any final tips for someone who thinks they may need a business valuation?

Speaker 3:

Yeah, final tips for someone that might need a business valuation definitely seek professional help. There's attorneys, cpas and then, obviously, business valuators who you're going to want to help you through this process. Keep your records updated. When somebody comes in to maybe potentially purchase your business, they're going to be digging through your records updated. When somebody comes in to maybe potentially purchase your business, they're going to be digging through your records and you want to make sure you have solid records. Understand the purpose so you know the purpose of a business valuation is a key driver and how you come up with a valuation. You know what a business is worth in a gift tax situation is not the same as what a business might be worth in a sale situation. So just understanding the differences between those and then, finally, just be realistic. Set realistic expectations. Be prepared for potential adjustments based on market conditions and other factors.

Speaker 2:

Love it, Tim. We'll catch you in the next episode. Have a fantastic rest of your day.

Speaker 1:

Thanks, you too thanks for listening to the knowing what counts podcast. Ready to optimize your wealth and protect your future, visit the mpgroupcpacom or call 413-739-1800 to connect with our team of experts. Remember, success is about knowing what counts.