5 Business Valuation Mistakes to Avoid

September 17, 2020, Posted by: Aaron DiCaprio

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Business Valuation Mistakes

Determining the value of a business is critical for every business owner. Business valuation involves a careful review of financial statements, including balance sheets and income statements. Because business circumstances change quickly, information must be current. By reviewing financial information regularly, business owners can more accurately adjust both short and long-term goals. Business valuation mistakes, however, can lead to bad financial decisions.

Avoid Business Valuation Mistakes

There are five critical business valuation mistakes that business owners must avoid to conduct an accurate assessment. Errors in the measurements can harm the business in significant ways. They can inflate the business value or result in missed opportunities. Any of these miscalculations easily find their way into the assessment, so it's critical to be aware of them.

1. Measuring the Wrong Business Value

The business value should be according to cash flow rather than accounting profits. The value must accurately depict earning power, and cash flow is the most direct measure. Profit is the part of the business picture that determines taxation. Cash flow, on the other hand, is a more accurate measure of financial health. It doesn't lend itself to manipulation, unlike earnings, so it's a better metric.

2. Selecting the Wrong Business Value Type

Business owners must base the valuation on the goal of the assessment. Three types include:

  • Fair market value - Used when selling the business
  • Investment value - Helpful for potential investors
  • Liquidation value - Applied when liquidating the business

3. Forgetting Key Assets and Liabilities

When selling the company, it is important not to leave out key assets and liabilities. Market-driven pricing depends on the assets at the time of sale. Any incoming assets increase the business value, and liabilities decrease the value. Typically, sellers pay off the liabilities, keep the accounts receivable and cash, and provide buyers with accurate information.

4. Assessing the Wrong Company-Specific Risks

Risk assessment is critical to business valuation. The evaluation can be misleading if it doesn't consider the specific risks of the company. Several operational and financial situations contribute to a business's risk profile. Since each company has different risks, these considerations must be company-specific.

5. Hiding Certain Operating Costs

The business valuation must include all operating costs. Employee benefits, including salaries and insurance coverage, are a type of operating cost. Small office equipment, such as printers and computers, are also expenses. Be careful to include chairs and desks as well.

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