April 25, 2018 | Valuations
Is business valuation an art or a science? In a training years ago, a panel of business valuation experts tackled this question, and could not come up with an answer. While the experts did agree that business valuation has elements of both science and art, they differed on which one was the predominant element.
Today the debate still goes on. There is still no consensus on what exactly a business valuation is, but perhaps a closer look can give some insight on the matter.
The Case for Science
As the practice of business valuation grows, there’s a clear trend to rely more on scientific evidence and methods. Professional valuators, for example, are more and more using things like regression analyses when projecting cash flows, quantifying discounts, and analysis of sales transactions.
When determining discount and capitalization rates used in the income approach, valuators look at the data sources that make up the building blocks of those rates. Another example is the way in which valuators are now using a number of scientific analyses to point out weaknesses in traditional studies of the discount for lack of marketability (DLOM). Emerging scientific methods to quantify DLOM include option models and input models such as the Quantitative Marketability Discount Model.
For as much concrete evidence that a valuator uses, the final number is always a result of that person’s professional judgement, with an estimate of value that is somewhat subjective. The resulting conclusion of value that derives from a valuation engagement is a hypothetical value and cannot be “proven” in the scientific sense.
The art part of business valuation is key component of the process. It is the part that makes it unique, both to the valuator and to the user of the valuation conclusion. An experienced valuation analyst adds to the scientific processes with experience and study to take into account those intangibles which impact the final valuation.
The specifics of the business being valued, the economy, the quality of management, and the state of the industry are some of the qualitative aspects a valuation analyst must think about when coming up with a number. Those things can only be done in an artful manner. Science will not help to evaluate the impact of those factors on the value of the business.
The importance of these artistic elements highlights the need to hire a trained valuation professional who’s earned credentials from a recognized appraisal organization.
The Best Mix
Valuing a closely held business requires a blend of quantifiable scientific methods and qualitative artful considerations. The user of a business valuation should feel comfortable that the value conclusion includes a proper mix of art and science. It’s this combination of art and science that ensures a quality estimate.
To learn more about valuations, contact Filler & Associates.