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Balance Sheet Technique > Business Valuation | Phasecorp Business Consulting Group in Chicago and Suburbs |
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| | The balance sheet technique is one of the most commonly used methods of evaluating a business, although it is not highly recommended because it oversimplifies the valuation process. This method computes the company's net worth or owner's equity (net worth = assets - liabilities) and uses this figure as the value. The problem with this technique is that it fails to recognize reality: Most small businesses have market values that exceed their reported book values.
The first step is to determine which assets are included in the sale. In most cases, the owner has some personal assets he does not want to sell. Remember that net worth on a financial statement will likely differ significantly from actual net worth in the market.
Variation: Adjusted Balance Sheet Technique. A more realistic method for determining a company's value is to adjust the book value of net worth to reflect actual market value. The values reported on a company’s books may overstate or understate the true value of assets and liabilities. Typical assets in a business sale include notes and accounts receivable, inventories, supplies, and fixtures. If a buyer purchases notes and accounts receivable, he should estimate the likelihood of their collection and adjust their value accordingly.
In manufacturing, wholesale, and retail businesses, inventory usually is the largest single asset involved in the sale. Taking a physical inventory count is the best way to determine accurately the quantity of goods to be transferred. The sale may include three types of inventory, each having its own method of valuation: raw materials, work in-process, and finished goods. The buyer and the seller must arrive at a method for evaluating the inventory First-in-first-out (FIFO), last-in-first out (LIFO), and average costing are three frequently used techniques, but the most common methods use the cost of last purchase and the replacement value of the inventory. Before accepting any inventory value, the buyer should evaluate the condition of the goods.
One young couple purchased a lumber yard without examining the inventory completely. After completing the sale, they discovered that most of the lumber in a warehouse they had neglected to inspect was warped and was of little value as building material. The bargain price they paid for the business turned out not to be the good deal they had expected. To avoid such problems, some buyers insist on having a knowledgeable representative on an inventory team that counts the inventory and checks its condition. Nearly every sale involves merchandise that cannot be sold; but, by taking this precaution, a buyer minimizes the chance of being stuck with worthless inventory.
Fixed assets transferred in a sale might include land, buildings, equipment, and fixtures. Business owners frequently carry real estate and buildings at prices well below their actual market value. Equipment and fixtures, depending on their condition and usefulness, may increase or decrease the true value of the business. Appraisals of these assets on insurance policies are helpful guidelines for establishing market value.
Business evaluations based on balance sheet method suffer one major drawback: they do not consider the future earning potential of the business. These techniques value assets at current prices and do not consider them as tools for creating future profits. The next method for computing the value of a business is based on its expected future earnings.
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Small Business Balance Sheet
The balance sheet boldly declares where a business stands at a given moment in time. From the balance sheet, a financially sophisticated reader can learn an immense amount of valuable information about a business and its viability. That is why potential investors and lenders will almost always ask you for a copy of your financial statements, including the balance sheet, income statement, statement of retained earnings, and statement of cash flows. Read more
| | Is Your Business In Balance?
A Balance Sheet is a financial document prepared by a business, organization or individual at the end of a fiscal year or other period, which depicts the assets, liabilities and shareholder equity of the company. Based on the double entry bookkeeping system, the balance sheet helps assess the net worth of the company at a given point of time e.g. end of fiscal year or some other arbitrary time. Read more
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Assets and liabilities may not sound as exciting as revenues and earnings but now is the time for business owners to increase their focus on the balance sheet. Balance sheet focus can provide an early warning system and help the business owners identify the company's shortcomings and improve the company's health and help the company survive or thrive as we exit out of this recession. Read more
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