Below are some of the more frequently used terms in the business valuation industry. As a current or prospective business owner, you may already be familiar with these terms and what they really mean to your business.
Adjusted Book Value
A method within the asset approach whereby all assets and liabilities (including off-balance sheet, intangible, and contingent) are adjusted to their fair market values.
Arbitrage Pricing Theory
A multivariate model for estimating the cost of equity capital, which incorporates several systematic risk factors.
Asset Based Approach
A general way of determining a value indication of a business’s assets and/or equity interest using one or more methods based directly on the value of the assets or the business less liabilities.
A form of acquisition whereby the seller of a corporation agrees to sell all or certain assets and liabilities of a company to a purchaser. The corporate entity is not transferred.
A measure of systematic risk of a stock; the tendency of a stock’s price to correlate with changes in a specific index.
An amount or percentage deducted from the current market price of a publicly traded stock to reflect the decrease in the per share value of a block of stock that is of a size that could not be sold in a reasonable period of time given normal trading volume.
With respect to assets, the capitalized cost of an asset less accumulated depreciation, depletion or amortization as it appears on the books of account of the enterprise. With respect to a business enterprise, the difference between total assets (net of depreciation, depletion and amortization) and total liabilities of an enterprise as they appear on the balance sheet. It is synonymous with net book value, net worth and shareholder’s equity.
The act or process of arriving at an opinion or determination of the value of a business or enterprise or an interest therein.
Capital Asset Pricing Model (CAPM)
A model in which the cost of capital for any stock or portfolio of stocks equals a risk-free rate plus a risk premium that is proportionate to the systematic risk of the stock or portfolio.
The conversion of income into value. The capital structure of a business enterprise. The recognition of an expenditure as a capital asset rather than a period expense.
Any multiple or divisor used to convert anticipated economic benefits of a single period into value.
The composition of a business entity’s invested capital.
Capitalizing Net Income
Determining a future value for the company by dividing the pro forma net income by the required Return on Investment (ROI).
Cash that is generated over a period of time by an asset, group of assets, or business enterprise. It may be used in a general sense to encompass various levels of specifically defined cash flows. When the term is used, it should be supplemented by a qualifier (for example, “discretionary” or “operating”) and a specific definition in the given valuation context.
An amount or a percentage by which the pro rata value of a controlling interest exceeds the pro rata value of a non-controlling interest in a business enterprise, to reflect the power of control.
The allocation of the consideration paid for a business. The components could include cash, notes, stock, consulting agreements, earnout provisions, and covenants not to compete. The sale could take the form of an asset sale or a stock sale.
A rate of return used to convert a monetary sum, payment or receivable in the future into present value.
The portion of the purchase prices that is contingent on future performance. It is payable to the sellers only when certain pre-defined levels of sales or income are achieved in the years after acquisition.
Earnings before interest and taxes.
Earnings before interest, taxes, depreciation, and amortization.
Inflows such as revenues, net income, net cash flows, etc.
The owner’s interest in property after deduction of all liabilities.
That amount of anticipated economic benefits that exceeds an appropriate rate of return on the value of a selected asset base (often net tangible assets) used to generate those anticipated economic benefits.
Fair Market Value
The price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arm’s length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts.
Financial recasting of the historical financial statements adds back items such as superfluous, excessive, or discretionary expenses and non-recurring revenues and expenses. Recasting provides an economic view of the company, and allows meaningful comparisons with other investment opportunities.
Free Cash Flow
Cash available for distribution after taxes but before the effects of financing. Calculated as debt-free net income plus depreciation less expenditures required for working capital and capital items adjusted to remove effects of financing.
An operating business enterprise.
Going Concern Value
The value of a business enterprise that is expected to continue to operate into the future. The intangible elements of Going Concern Value result from factors such as having a trained work force, an operational plant, and the necessary licenses, systems, and procedures in place.
Goodwill or Intangible Value
The amount by which the consideration paid exceeds the fair market value of the company’s operating assets.
A general way of determining value of a business, business ownership interest or security using one or more methods wherein a value is determined based on anticipated benefits.
The intangible assets will usually consist of goodwill and going concern value, certain types of intangible property that generally relate to the workforce, information base, know-how, customers, suppliers, or systems in place producing cash flow, proprietary rights (such as; patents, copyrights, trade marks, or trade names), covenant not to compete or similar items.
The value that an investor considers, on the basis of an evaluation or available facts, to be the “true” or “real” value that will become the market value when other investors reach the same conclusion. When the term applies to options, it is the difference between the exercise price or strike price of an option and the market value of the underlying security
The sum of equity and debt in a business enterprise. Debt is typically a) all interest-bearing debt or b) long-term interest-bearing debt. When the term is used, it should be supplemented by a specific definition in the given valuation context.
The act or process of determining the value of a business, business ownership interest, security, or intangible asset with limitations in analyses, procedures, or scope.
The value of a company assuming the assets of the company are sold piecemeal (not as part of an ongoing business enterprise) with-appropriate time ‘ for exposure to the marketplace.
A general way of determining a value indication of a business, business ownership or security using one or more methods that compare the subject to similar businesses, business ownership interests or securities that have been sold.
A factor that can be applied to the subject company’s financial, operating or physical data to generate an indication of value. The market multiple is derived from observed transactions in the marketplace where the value can be divided by the comparable companies’ financial, operating or physical data to generate the market multiple.
Net Book Value
With respect to a business enterprise, the difference between total assets (net of accumulated depreciation, depletion, and amortization) and total liabilities as they appear on the balance sheet (synonymous with Shareholder’s Equity). With respect to a specific asset, the capitalized cost less accumulated amortization or depreciation as it appears on the books of account of the business enterprise.
Net Cash Flow
Cash available for distribution after taxes and after the effects of financing. Calculated as net income plus depreciation less expenditures required for working capital and capital items.
Revenue less expenses, including taxes.
Assets shown on the company’s balance sheet that are not used in the operation of the business. That is, “extra” assets that are not necessary to generate the revenue and cash flow stream being valued.
Normal Working Capital
The amount of working capital needed by the company to sustain operations throughout the year. Calculated as the average of current assets (which include a normal amount of necessary cash) minus current liabilities on a monthly basis over the most recent twelve months.
Orderly Liquidation Value
Liquidation value at which the asset or assets are sold over a reasonable period of time to maximize proceeds received.
The value today of a future payment, or stream of payments, discounted at a risk-adjusted rate of return.
Pro Forma Statements
Hypothetical statements. Financial statements as they would appear if some event, such as increased sales or production, were to occur.
Rate of Return
An amount of income (loss) and/or change in value realized or anticipated on an investment, expressed as a percentage of that investment.
A form of acquisition whereby all or a portion of the stock in a corporation is sold to the purchaser.
Tangible assets that may be included in the sale of a business usually consist of accounts receivable, inventory, leasehold improvements, furniture and fixtures, equipment, land and building.
The value of the company at the end of the five-year pro forma period. Terminal value is determined by dividing the fifth year pro forma cash flow (normalized for depreciation and capital expenditures) by the required Return on Investment.
A general way of determining value using one or more specific valuation methods. (See Asset Based Approach, Market Approach and Income Approach definitions.)
Within valuation approaches, a specific way to determine value.
A factor wherein a value or price serves as the numerator and financial, operating or physical data of the company being valued serve as the denominator.
The amount at which a business enterprise passes from a willing seller to a willing buyer. It is assumed that both buyer and seller are rational and have a reasonable knowledge of relevant facts.
The excess of current assets over current liabilities.