June 25, 2015 | Valuations
For small business owners, it may seem like all you need is a little business and financial knowledge to perform a quick calculation to determine a business’ value. However, experienced valuation professionals apply tested valuation approaches that are based on real world market data, and, importantly, they have strong verbal and written communication skills that let them clearly explain and support their appraisal conclusions.
Verbal Reports vs. Written Reports
Valuators can report their conclusions either verbally or with a written report. A verbal report may suffice in some limited situations, like when management is curious about the company’s value. Sometimes attorneys may choose a verbal report if they are trying to keep fees lower during a settlement process
That strategy can often backfire in the courtroom. Judges usually prefer to have an actual written report for reference during expert testimony. With a verbal report, attorneys have to be very adept at asking detailed, technical questions to show the entire story behind the valuation. For these reasons, a written report is usually the best option.
A valuation report should tell the story of the business being valued. A reader needs to know that the valuator completely understands the business. Also, a written report will document the research, analysis, and methods used to value the business. It’s the valuator’s job to build a clear and logical case for how and why the valuation conclusion was reached. After reading a valuation report, the reader should have a basic understanding of the business, understand how and why the valuation was reached, and see how the conclusion makes sense, even if they disagree with it
Assessing the Quality of a Written Report
While there is no set number of pages in a well-done valuation report, it is definitely not possible to explain a business thoroughly in just a few pages. Usually, valuation reports start with an executive summary of the company and also cover some of the following:
- Definition of the assignment. A valuator should identify basic details about the company, such as size, intended uses, and when the company began operating as a business. The valuator should also identity which standard of value they are using to assess the company.
- Description of the business. This is where the valuator will show that they totally understand the nature of the company, including strengths, weaknesses, as well as any opportunities or threats. Any mistakes here will compromise the validity of an appraiser’s conclusions.
- Industry and economic trends. External factors affect future cash flows and perceptions of risk, which, in turn, impact how much a company is worth. This section tells whether an expert understands the environment in which the company currently operates.
- Financial analysis and adjustments. Past performance can provide insight into future cash flows. Value is impacted by how well (or poorly) a company has performed in the past — or relative to other companies in the same industry. Sometimes the company’s financial statements require adjustment for discretionary or nonrecurring items — or for unusual accounting practices.
- Valuation methods. Appraisers generally consider three approaches when valuing a business: the cost, market and income approaches. This section should discuss which method the valuator chose, and why.
- Discounts and other considerations. Sometimes valuations call for discounts, such as those for lack of control or marketability. This section of the report discusses which discounts are appropriate and why. It will also provide evidence to support the discount rates chosen.
- Appraisal conclusion(s). A reader should be able to follow the report, like a story. The conclusion should make sense based on all the evidence that is shown.
There are often various appendices that appear at the end of a comprehensive valuation report. These may include the valuator’s qualifications, statements of assumptions and limiting conditions, bibliographies, and numerical exhibits and graphs.
Litmus Test: Do You Understand?
A comprehensive report explains the valuator’s thought process and provides market evidence to support his or her assumptions, methods and conclusions. The most important thing to remember when considering valuation reports is that if it isn’t easily understood or doesn’t make basic sense, it’s worthless. For more information about valuations, contact Filler & Associates