Chapter 12- Business Valuation and Financial Statement Analysis Flashcards
What is business valuation or apparisal?
option of the value of an asset or ownership interrest in a bsuiness enterprise.
Final valuation assigned to any business interest is actually a derivation of what?
Fair Market Value
“the price at which the property would change hand between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts”
What are the 8 general factors to be taken into a consideration in the construction of any business appraisal?
- nature and hx of the company
- general economic and industry outlook
- book value and financial condition of the company
- earnings capacity of the company
- dividend-paying capacity of the company
- value of goodwill or total intangibles
- size of business interest under consideration
- market price of comparable public company stocks.
When would a professional valuation report be considered useful to business owners and investors?
- sale or purchase of a business
- tax-related valuations
- marital/corporate/partnership dissolution
- employee stock ownership plans
- Initial public offerings (IPOs)
- stockholder disputes
- establishment of a buy-sell agreement
- damage cases
The content/format of business financial statements comprise what uniform characteristics?
- income statement
- balance sheet
- cash flow statement
* can differ by industry, company size, organization and activity.
What are Financial ratios?
measure the relationship amoung different items in the financial statement.
Define liquidity rations
reveal a companys ablity to cover short-term debt and answer the question “ is bankruptcy a possibility’
- ratio is assets/libabilities. Generally a ratio if 2:1, higher ratio is more favourable
- quick ratio is (current assets - inventory)/liabilities.
Define Debt ratios
reveal a company’s long-term solvency “is this comapny struggling?”
> ratio is: (total debt/total assets) higher ratio is more risky
> debt to equity ratio is (total debt/total equity). higher ratio is riskier
Define profitability ratios
Measures a company’s ability to generate income and answer the question “is company profitable”
- net profit margin is net profit before tax divided by total sales
- return on asset is net income divided by total assets. low ration idivates inefficent use of assets.
- return on equity is (net income/shareholder equity)
Traditional valuation methodologies rely on what?
analysis of the existing financial statements of established businesses.
- good when companies have been established for several years.
What is the capitalization of earnings method?
based on the concept that the value of a business is its ability to produce profits.
- requires several years of financial data. Average income is then mutipled by a factor representing the return an invester might expect from investing capital in business.
Expected investment return (IR) varies for different types of business. What would be the expected IR and Factor for an old, established business in a moderately competitive industry, significant hard assets, stable earnings, experienced and stable management, excellent goodwill, predictable feature.
IR 8-10%,
Factors 12-10x
Expected investment return (IR) varies for different types of business. What would be the expected IR and Factor for an old, established business in a highely competitive industry, significant hard assets, stable earnings, experienced and stable management, excellent goodwill, predictable feature.
IR 11-15%
Factor 9-7x
Expected investment return (IR) varies for different types of business. What would be the expected IR and Factor for an a highly competitive bsuiness with few hard seets, small by experinces managerial staff and good historical earning record
IR 16-20%
Factor 6-5x
Expected investment return (IR) varies for different types of business. What would be the expected IR and Factor for a small business dependent on the expertise of a very few people or large companies in highly cyclical industries without predictable or stable profits.
IR 21-25%
Factor 5-4X
Expected investment return (IR) varies for different types of business. What would be the expected IR and Factor for a small personal service business with a signle owner?
IR 26-30%
Factor 4-3x
What is the adjusted book value method?
concentrates on a company assets and liabilities rather than income.
- adjusment of values assigned for each of the firms assets and libailities from their historical costs to their current FMV.
What is recasting financial statements?
process that brings statement more in line with the true ntature of the company;s current financial position.
ABV method for analyzing a balance sheet is useful which kinds of business?
- real estate development firms who derive income from buy and selling holdings at FMV
- holding companies that own other business or income producing investments
- firms that are marginally profitable and have a value comprised mostly of their liquidity
- firms that have large asset bases and those that own property not used in the function of the business
When do you use Alternative methodologies?
situations when the business may not be long-established or may not have financial statements.
-typicall analytical approach such as family-owned company
What is the discounted future earnings method?
variation of the capitalization of earnings technique, but the emphasis is placed on future earnings instead of historical performances
- good for businesses without a track record of earnings
How do you perform the discounted future earnings method?
- determine expected business profits future a future period of time.
- discount future earnings to their present value by multiplying the expected profit times the discount rate for each year.
- discount rate = rate of return an invester could expect
- 5 years of discounted profits are added together to arrive at the present value of the business.
What is the price to earnings (P/E ratio)
- useful situation where closely-held business is the subject of the valuation exercise.
- hard to determine FMV.
- comparison from one company to others that are similar is done to analyze a relationship between earnings and the price of the comparable company.
- Ratio is then applied to earnings of the business to be values.
What is the similar property method?
value of a similar company recently sold on the open market can serve as an estimate for a business currently undergoing valuation.
What is Goodwill?
an intangible asset that increases the value of a company as a resul of name, reputation, customer, loyralty, location, product or toher factors.
How can you measure/record goodwill?
- excess difference between FMV of company assets and the FMV of the organization as an entity
- excess difference between the return on a company assets invested at current rates of return and actual profits produced by the business.
True or False
goodwill is usually noted only on the balance sheet of the company as an asset.
True,
Note deduction of a company’s goodwill on their income statement can be a clue that the company is not as financially healthy as it once was
What is the value of human capital?
valuation of management expertise of a company executives and the tech skills of the rank and file employees
what are examples of closely-help firms with unique tax advantages?
sole proprietorships and partnerships, an subchapter C and S corporations
- income taxed once and income is passed through the company to the business owner.
What are the major changes on the financial statements of a closely-held business?
- profits are likely to be understated in situations where most or all income is paid out to the ciompany owners
- personal expenses may be included, delivertaly or otherwise in the financial statements are busiess expenditure.
What are some unique features about farms and financial statemnets
principal asset = land,
-characterized as a tangile, renewable resource and is carried on the financial statements at historical cost.
How can farmland be valued?
according to present use or potential use.
- IRS has special rules that govern the valuation of farmland.
40% of start-up business survive the first 5 years. What are the most critical factors affecting business survival?
- amount of time the company has existed
- financial strength
more capital = longer its been in operation.
What 5 characteristics thrive the potential for new company’s continued survival?
- cash flow
- management expertise
- technical expertise
- capitalization
- debt load.
What needs documented need to be used to assess the value of a start-up company ?
pro-formal financial statements
business plan documents
what is included in a small business administration of the US governments
- executive summary
- market analysis
3, company description - company organization and management
- markerting sales and management
- service or product line
- funding request
- financials
What is a business continuation agreement (buy-sell agreement)
agreement to specify the rights of all the company co-owners and to provide an agreed-upon method of valuing the business interest.
What are some benefits to a propoerly constructed buy-sell agreement?
- means of determining an equitable price for the business interest
- mechanism for liquidating and disposing ownership interests.
- prevention fo the sale of the business to outsiders
- determination of a binding price for estate tax assessment
- a price and liquidation mechanism for divorce proceedings
There are 3 types of buy-sell agreements, what is a cross-purchase
remaining business partners agree to purchase the business interest of the deceased or departing partner for a specified proiice
There are 3 types of buy-sell agreements, what is an entity agreement?
used by corporations.
coroporation will be obligated to purchase the shares of stock from the estate of the deceased
There are 3 types of buy-sell agreements, what is a one-way buy-sell?
rare
older business owner (sole proprietor or stockholder) wans thte business inherited by specific beneficiary.
What are items of financial underwriting that are of concern?
- lack of a buy-sell agreement for established companies or lack of a business plan for a new business.
- no discernible relationship among the amount of insurance applied for, business valuation, and results of financial companies. All factors are inter-dependent and relationships should exist.
- financial data which raises the question about the company’s fiscal well-being, especially poor profit levels, declining sales, no financial rations and high debts can not be sustained.
