All You Need To Know About Business Appraisal + 4 Methods

If you want to expand or sell your business now or in the future, it’s critical to know your current financial standing. Getting a business appraisal gives you a comprehensive overview of your company’s economic value so you can make informed decisions to drive your business forward.

What is a business appraisal?

In this valuation method, a certified appraiser measures your company’s financial performance and the fair market value of any physical assets, real estate, intellectual property, and intangible assets. A business appraisal, also referred to as a business valuation, also takes your company’s debts or liabilities into account, along with evaluating specific industry or economic circumstances that impact your company’s financial health.

Why is it important?

Without a business appraisal, business owners may not have an accurate or complete picture of what their company is worth, which can lead to financial mismanagement or poor business decisions that harm their performance.

Understanding your true financial situation through a business appraisal is key to managing your business when you’re applying for loans or searching for investors to grow your company. You’ll also need a business valuation before negotiating any merger or acquisition (M&A) deal to sell your business or make a succession plan. Once you know where your business stands financially, you can make strategic decisions to maximize your outcomes.

The Basics of a Business Appraisal

A business appraisal is more than a simple financial analysis of your company. An independent appraiser or a certified valuation analyst (CVA) will use multiple business valuation methods to determine your cash flow, assets, and market value and compare your business with competitors in your industry.

How To Know if You Need an Appraisal

A business appraisal gives you key insights into your financial health and goals, so it’s a great tool for your company to utilize at any point. However, there are certain times when it’s not only financially smart to get an appraisal but necessary, including when:

• Buying or selling a company: Getting an accurate resale value of a business is key, as you don’t want to overpay when purchasing a company or not receive your worth when selling your business or working with a business broker.
• Negotiating financial deals: A valuation of your business may help you get more favorable terms when applying for loans or seeking out investors.
• Planning for a business owner’s retirement: Succession planning is critical for maintaining your company’s financial health during an owner’s exit. An appraisal offers a clear picture of your liquidity and assets to make this process easier.
• Disputing legal disagreements: Conflict between shareholders or contract violations can hurt your company’s financial wellness. An independent appraisal brings objectivity to the dispute, so it can be resolved quickly.

Preparing for an Appraisal

For an accurate and comprehensive business appraisal, the appraiser will need access to certain financial information. Depending on the appraiser’s valuation method, you can prepare ahead of time by gathering financial reporting, including your balance sheet or cash flow statements. Also, create a list of all your physical assets (such as buildings or real estate you own and any inventory, equipment, or machinery) and intangible assets like intellectual property. Your business appraiser will also want to see documentation of any outstanding debts or liabilities and future business projections.

You should estimate the business appraisal cost and include it in your budget. Certified valuation analysts typically charge by the hour, so depending on the size of your company and the number of assets a business appraiser has to evaluate, appraisal costs can be anywhere from a few thousand dollars to more than $30,000.

Business appraisal vs. business valuation: What are the differences?

While the terms are often used interchangeably, there are key differences between a business appraisal and a business valuation. The differences lie in how assets are valued and whether the findings have legal standing.

Physical Assets vs. Intangible Assets

The value of your company’s physical assets, including any inventory, warehouses, machinery, and real estate, is typically appraised. A business appraiser will evaluate these assets based on numerous factors, such as their condition or replacement cost, along with their current market value.

In comparison, the valuation method is used for intangible assets, such as your company’s customer lists and data, intellectual property, and trademarks. This type of asset is more difficult to assign value to since there is no comparable fair market value. However, getting a company valuation of your intangible assets is key, as they can be of significant value to your overall worth.

Legal Standing

Business appraisals don’t offer the same legal standing as a business valuation does, as an appraisal is a simple price guideline for your assets. Business valuations, on the other hand, clearly define an asset’s value and are useful for succession planning or when legal disputes arise.

4 Types of Business Appraisals

Now that you understand the difference between an appraisal and a valuation, here are some common physical things businesses can appraise that help determine a business’s value.

Business Assets

All of your revenue-generating real items can be appraised, including your accounts receivable, any buildings or land that your company owns, your business inventory (and any financial resources used to buy or make your inventory), and all machinery and equipment. To calculate your company’s asset book value, your appraiser will subtract any debts, loans, and other liabilities from the value of your appraised business assets.

Capitalization of Earnings

This appraisal method is an income approach to valuation that evaluates your current earnings by calculating your net present value along with your annual rate of return and expected cash flow and profits in the future. Your business appraiser will examine financial documents for earnings or gains, weighing more recent earnings higher than past earnings. Then, this amount is divided by the capitalization rate, which is a formula that divides your operating income by the purchase price, to calculate the final value.

Future Earnings

Your business can even appraise its future expected profits. A discounted future earnings appraisal can estimate your company’s value using your forecasted earnings. After calculating your predicted future earnings, your appraiser will apply the discount rate, which converts future dollars into present-day value to determine your worth.

Capitalization Factor

Appraisers use the capitalization factor, which is also called the capitalization rate or cap rate, to convert the expected income or returns from investments to value business earnings or cash flow. The capitalization rate is calculated by dividing your net operating income by the current market value. A higher capitalization rate generally indicates a greater level of risk, but a lower rate can mean smaller returns.

What is the rule of thumb for valuing a business?

While every business has unique value drives that impact its worth, there are some time-saving tips that small business owners and business brokers can apply to make the valuation process easier. Consider one of the following rule of thumb methods to quickly estimate the value of your business:

• Multiply EBITDA: Take your annual earnings before interest, taxes, depreciation, and amortization (EBITDA) and multiply it by the 2x-6x EBITDA range to calculate your business value. Your multiplier will depend on the size of your company along with other factors like profit margin, your industry, and potential for growth.
• Examine Discretionary Earnings: Determine your business’s value by first adding together your owner’s salary and other discretionary income or profits they earn (things like benefits, bonuses, company cars, etc.). Then, multiply this amount by a factor ranging from 1x to 4x for the estimated business value.
• Calculate Revenue Multiple: This calculation multiples your annual revenue or sales by a factor of .5x to 5.0x, depending on your company’s industry.

Determine Your Company’s Value With Podium’s Business Calculator

Small business owners often have tight budgets, and they may lack the resources they need to afford a business appraiser or CVA. That’s where Podium’s Business Valuation Calculator comes in. This free tool can help you better understand your company’s financial standing—so you can make data-driven decisions and plan for growth.

How does it work?

The calculator first determines your company’s gross profit, EBITDA, and EBITDA percentage by evaluating a number of financial factors and business assets. Then, it uses this data to determine a more comprehensive business valuation.

What does it take into account?

The calculator takes many elements into account when determining a valuation, including:

• Revenue from the past year
• Direct costs of producing your services or goods sold
• Overhead costs like rent and employee salaries
• The total value of your business assets

How reliable is it?

Its reliability depends on your data’s accuracy. Also, remember that a business valuation and appraisal are two different concepts. This valuation calculator shouldn’t be used for appraisal purposes, but it can help you understand your company’s position in the market and develop insights to guide future business decisions. Try our Business Valuation Calculator today to gain a complete picture of your financial standing.