When valuing a business, various economic factors are taken into account in order to arrive at a far market value. These could include applicable taxes and government policies, among others. Valuers use predetermined formulae to help them calculate the value of a business, and a balance sheet provides critical financial information on that business, making it an integral part of any valuation.
A balance sheet reflects the present financial position of a company at a specific point in time. It summarises assets, liabilities and net worth, and gives an accurate indication of what the company owns and owes. Together with income statements, a balance sheet tells lenders – such as investors, banks and vendors – how much debt the company has, how much it needs to collect from its customers, how much cash it has, and how much it has earned over time. This gives them a sound financial basis on which they can base the amount of credit they’re willing to extend.
A balance sheet is also absolutely critical when it comes to the valuation of a business. It gives the value of assets – such as cash and inventory (short-term and current) and equipment and furniture (long term) – and liabilities, which can include loans, leases, credit lines and accounts payable. The book value of a company – which is often used as a base valuation method for a company – is calculated subtracting the total liabilities from the total assets.
There may also be non-operating assets shown on the balance sheet. These could include property – such as a warehouse – that has increased in value since it was purchased, or long-term investments made to fund future expansion.
Balance sheets can also show intangible items, such as intellectual property. This could include copyrights, licenses or proprietary software.
When it comes to using the information contained in a balance sheet to facilitate the valuation of a company, there are three main methods – book value, adjusted book value and liquidation value.
Book Value – this looks at the numbers from the company’s financial records, as depreciated at the time of the sale. This can create difficulties for sellers, especially if they have depreciated the assets too much to gain prior tax advantages.
Adjusted Book Value – this method requires the total value to be offset against the sum of the liabilities and is determined by revising the book value of the asset so that it reflects the replacement value of the assets in their current condition.
Liquidation Value – this is the amount that would be realised if all the assets, such as inventory, furniture and equipment, were sold separately. This is usually a much lower value as it doesn’t take into account the intrinsic value of the company.
The Property Partnership East Rand can help you determine the most accurate market value (also referred to as fair value), for balance sheet valuations, among many others. Contact us today to find out more.