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Valuation Principles and Approaches Explained

TITLE: Valuation Principles and Approaches Explained - a primer on business valuation concepts ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ CHAPTERS 0:00 - Introduction 0:13 - Principle of Substitution 0:24 - Highest and Best Use 1:08 - The Market Approach 1:22 - The Earnings Approach 1:47 - The Asset Approach 2:03 - Choosing Approaches and Methodologies ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ TRANSCRIPT Principle of Substitution - Business valuation is based on the principle of substitution, which asserts that the value of an item is equivalent to the cost of acquiring a comparable substitute. Highest and Best Use - Valuation professionals assess the 'highest and best use' of a business. We look at the optimal means of generating value from the business under market conditions and determine whether to evaluate it based on its liquidation value or as a going concern. If discontinuing operations (liquidation) is deemed appropriate, we convert assets and liabilities to their expected cash values over the wind-down period, factoring in related operating, legal and other expenses. Alternatively, if continuing operations is preferable, the focus shifts to the business’s earning power and cash-generating capabilities. Here we consider the market, earnings, and asset-based approaches. The Market Approach - The market approach uses information from transactions of comparable businesses, ideally with similar business models and capital structures, in the same industry and subject to similar economic, environmental, and political factors. The Earnings Approach - The earnings or income approach assumes that an equally desirable substitute for the business would have similar investment characteristics. The normalised expected future profits are estimated and converted into a current value. Per industry standards, valuation reliance on rules of thumb is considered inappropriate, as every business, operating environment and valuation engagement is unique. The Asset Approach - The asset approach leverages the principle of substitution. If a perfect substitute for a business would be a replica of its underlying assets, its value could be estimated by adding the value of all its assets and subtracting its total liabilities. Choosing Approaches and Methodologies - Industry standards endorse the use of all appraisal approaches but recognise that selecting the approaches and particular methods appropriate to the specifics of a particular engagement is a matter of the appraiser's professional judgment. ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ABOUT US We help owners and operators of private companies measure, grow and harvest business value. Looking to engage with us? Take a free 2-minute readiness assessment at www.firmadvisory.com/get-started Playlists:    / @firmadvisory   Website: firmadvisory.com Email: support@firmadvisory.com LinkedIn: linkedin.com/company/firm-advisory Facebook: facebook.com/firmadvisory Instagram: instagram.com/firm_advisory_bm YouTube:    / @firmadvisory