Many business owners believe the value of their business is net profit, or gross sales, multiplied by some industry rule of thumb. It’s not. In fact, using an industry rule of thumb formula often results in a value determination that differs greatly from the actual value that could be determined by a qualified business valuation professional.

An inaccurate value determination, regardless of whether it is high or low, generally leads to undesirable consequences.

Likewise, if you are involved in a dissenting shareholder action or divorce, you certainly want to know you are receiving a fair value for your interest. Thus, a valuation that is high or low may not lead to desirable results for owners and interested parties.

The true value of a business is based on two kinds of assets: tangible and intangible.

Quite often, the value of a company’s intangible assets is much greater than the tangible assets. Valuing intangibles, however, is where one needs the services of a qualified business valuation professional: it requires a careful analysis of many aspects of a business enterprise and requires skills acquired through specialized training and experience.

To value intangibles, the valuator must understand every aspect of the enterprise dynamics, including:

All of these elements affect the risk of an ownership interest in a particular enterprise, and risk affects value.

The valuator must also analyze the financial health of the enterprise and assess its future profit potential. Generally, profitability translates into intangible value and/or goodwill, so a key part of the valuator’s analysis will focus on making adjustments to determine a company’s true profitability. Common adjustments include: