The most obvious reason for having your business valued is because you want to sell it. Consequently many business owners assume that if they are not planning to sell the company, it's not necessary to know its value.
But there are other times when you should know the value of your company such as when planning for its future, applying for bank loans or establishing tax liability.
If you are the owner or a partner in a closely held business, assessing the value of your company may not be simple. Unlike public companies, whose values are determined partially by the forces of the market, closely held businesses must look to factors such as normalized income, cash flow and assets.
A normalized earnings statement is one way to present an accurate picture of the operating performance of your company.
A typical earnings statement reflects all the financial activities of a business for a given year or period. In addition to income and expenses related to operations, it takes into consideration the specific actions of the owner or owners, outside investments and other activities not related to the business itself and non-recurring events.
In other words, income statements in themselves don't necessarily reflect the company's ability to grow or generate future income.
The compensation that owners pay themselves, for example, may or may not reflect the fair market value of their services. It's not unusual for owners to compensate themselves with company earnings rather than drawing a salary, and this lack of objectivity in the area of compensation means that income statements may not reflect the actual value of the owner's services.
Therefore, during the normalization process, the owner's value to the business must be assessed objectively. Do the owners bring unique benefits to the future of the business? What compensation would be needed to replace them?
Other important considerations: Does the business rent equipment or facilities from the owners? Are there retired stockholders receiving dividends? What fringe benefits does the ownership receive?
Frequently, a business generates income that is not tied to its operations. These items are removed when normalizing earnings statements. Examples include income from real estate not currently being used by the business, or income from securities and investments not tied to operations.
On the expense side, if a company has invested a significant sum in new-product development or employee training that is not expected to pay dividends in the short term, the investment should probably be capitalized and amortized.
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