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Copyright Gold Coast Schools2
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Learning Objectives
Describe the characteristics of the legal entities a business appraiser may encounter
List at least 5 reasons for a business appraisal
List the 5 steps in the business appraisal process
Describe at least 3 specific problem areas in a financial statement that may distort the firm's true economic value
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Learning Objectives
Explain the differences between cash basis accounting and accrual basis accounting;
Calculate the important financial ratios
List and describe the 4 approaches to estimating business value
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Similarities to a Real Estate Appraisal
Estimate market value
Differences
Appraiser must be able
– To read
– Understand
– Interpret financial statements
– inventory valuation
It may be necessary to be able to value intangible assets such as goodwill, licenses and franchises
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Business Appraisal Definitions
Going concern - value of a business as an
ongoing enterprise
Liquidation value - consistent with a forced or
hurried sale of the business assets
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Reasons for a Business Appraisal
Contemplated sale or purchase of a business
Allocation of value to specific assets
E.G. The sale of part of the business
Financial reporting purposes
Buy-sell agreements
Liquidation of the business
Divorce
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Reasons for a Business Appraisal
Estates and inheritance tax
Beneficiary of the estate gift receives the
gift free of tax
Tax is paid by the estate
Basis of property received is the fair market
value at the time of death
Condemnation proceedings
Determination of insurable value
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Business Appraisal Process
Define the assignment
Establish the date of the appraisal
Collect the data
Analyze the data
Prepare the final estimate
Prepare the appraisal report
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Report Includes
Summary and conclusions
Purpose of appraisal
Definition of value estimated
Insurance, cost, market, etc.
Description of subject business
Appraisal effective date
Description of appraisal process
Summary of facts derived from data
Statement of conclusions
Assumptions and limiting conditions
Supporting data, maps, financial statements and other
exhibits
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Financial Statements
Balance sheet
Statement of financial position at a point in
time
Income statement
Gives the results of operations over an
accounting period
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Problems with Accounting Principles
Estimates are necessary
Assets are reported at cost
Book value is original cost less depreciation
– Excluding land
Appraisers should restate value to market
value
Valuation accounts do not reflect value
Assets or liabilities may be missing
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Accounting Methods
Cash
Income is recognized when received
Expenses are recognized when paid
Accrual
Income is recognized when earned
Expenses are recognized when incurred
(liable)
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Inventory Costing Methods
First-in, first-out (FIFO)
Produces the higher gross profit in periods
of rising inventory costs
Last-in, first-out (LIFO)
Produces the most conservative estimate of
gross profit in periods of rising inventory
costs
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Analyzing Financial Statements
Construct historical series of financial statements
Calculate financial ratios over time
Current assets
– Cash or any item that will be converted to cash within the next 12 months
Current liabilities
– Due for payment within the next 12 months and paid with current assets
= Current Ratiocurrent assets
current liabilities
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Understanding Financial Statements
= Inventory turnover ratioCost of goods sold
Inventory
= Quick RatioCurrent Assets – Inventories
Current liabilities
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Understanding Financial Statements
= Debt to Worth RatioCompany Liabilities
Tangible Net Worth
= Net Profit to Owner CapitalNet Profit
Total Capital
• Investigate unusual items and results
• Vertical analysis is a review of various
income and expense categories relative to
a business’s gross profit
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Valuation Purposes
Adjusted balance sheet
Assets and liabilities
Consistent with the industry
Market value balance sheet
Assets and liabilities at market value rather
then cost
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Understanding Financial Statements
Adjusted income statement:
States income and
Expense items
In a manner consistent with industry
standards
Pro forma income statement (projected)
Estimate of operations for the next year
Most important income statement when using
the income approach to value estimation
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Valuation Methods
Sales comparison approach
Price to sales ratio = selling price / annual
sales
Price to earnings ratio = selling price / annual
net income
Cost approach
Income approach
Liquidation approach
Anticipated proceeds from the sale of all tangible
assets - liabilities
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Valuation of Intangible Assets
Goodwill
Business
Personal
Separable intangible assets
Franchises
Licenses
Copyrights
Leasehold benefits
Trademarks