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Business Appraisal

The ledger, opened

How a business is valued, read line by line

Business Appraisal is a guide to how businesses are valued in Australia, written and published by Dotto. It reads the official sources the way a bookkeeper reads a ledger: one line at a time, with a glass over the line that matters.

For the Australian Taxation Office, market value is an estimate, in money, of what an asset would bring on the open market at one point in time. Two things shape it: the asset’s most valuable use, and the figure a willing buyer and seller dealing at arm’s length would agree on. A valuation is an estimate, and the ATO expects it to rest on the most relevant and reliable information known, or reasonably foreseeable, at the valuation date.

A brass and horn magnifying glass lying on old botanical prints of ferns, roses and wild strawberries
Photo by lucas mendes on Unsplash
A ledger page with a magnifying glass A green-ruled ledger page listing the three valuation approaches: the market approach looks at comparable sales, the income approach at expected income, and the cost approach at the cost to replicate. A brass bar magnifier lies along the income line and enlarges it. APPROACHLOOKS ATMarket approachcomparable salesIncome approachexpected incomeCost approachcost to replicate APPROACHLOOKS ATMarket approachcomparable salesIncome approachexpected incomeCost approachcost to replicate
The ATO names three internationally defined valuation approaches: market, income and cost. Folio 2 sets them side by side.

1Market value

Market value, in plain words

For tax, the ATO uses the International Valuation Standards Council’s definition, which it considers consistent with what Australia’s courts have said market value means.

Put simply, market value is the amount a “willing buyer” and a “willing seller” would be expected to settle on for an asset on a given date: two strangers, both well informed, neither under pressure, after the asset has been properly put before the market. The definition itself is the International Valuation Standards Council’s; the ATO reproduces it in its guide Market valuation for tax purposes.

Every phrase carries weight. The buyer and seller are hypothetical: neither overeager nor forced, and the actual owner’s circumstances are set aside. The figure is fixed to one date, because markets change. And it leaves out any value that only one particular owner or buyer could get.

Folio 1 reads the definition phrase by phrase, and shows why a price and a market value can part company.

2Approaches

Three approaches, and a second look

The three approaches as the ATO’s guide describes them.
ApproachWhat it rests on
MarketPrices in actual transactions, and asking prices, for comparable assets.
IncomeThe income or cash flows the asset can be expected to generate in future.
CostThe market cost of replicating the asset in a similar condition at the valuation date.

For tax purposes the ATO recommends, where possible, a secondary or cross-check method to support the primary one. business.gov.au makes a similar point for owners: there is no one set valuation method, and a combination can be used.

Folio 2 compares the approaches, and Folio 3 works through the profit figure an income approach starts from.

3When

When a valuation is needed

business.gov.au describes working out what a business is worth as an important part of getting finance, attracting investors or selling. Tax law asks for one too. The ATO lists situations where a market valuation may be needed, including:

  • non-arm’s length transactions, such as transferring property or shares between family members
  • small businesses meeting the asset threshold tests for the capital gains tax concessions
  • businesses that consolidate for income tax purposes
  • employees receiving shares or options under an employee share scheme

Folio 4 covers what the ATO expects a valuation report to contain.

4Who

Who does the valuing

The ATO says plainly that there is no formal admissions board in Australia for business valuers, and that for tax purposes the acceptability of a valuation usually depends on the process followed rather than on who followed it.

The Accounting Professional & Ethical Standards Board writes the standards that bind accountants in the three professional bodies: CPA Australia, the Institute of Public Accountants, and Chartered Accountants Australia and New Zealand. Its standard APES 225 Valuation Services covers members whenever they estimate the value of a business, a share in one, or another asset, whether the work is for a client or for their own employer.

Folio 6 explains APES 225’s three kinds of engagement, and Folio 5 lists the records a sale draws on.

5Index

The six folios

Each folio takes one question about valuing a business and answers it from the ATO, business.gov.au, ASIC and the standard’s own publisher.

  1. What a business valuation isMarket value, read phrase by phrase, and why it is not the same as a price.
  2. Ways businesses are valuedThe market, income and cost approaches, side by side.
  3. Normalising earningsAdjusting a year’s profit before anyone values it, with a worked example.
  4. Valuations for taxWhen the ATO needs a market value, and what it expects to see.
  5. Getting a business ready to sellRecords, leases, staff and the business name, in order.
  6. Who can value a businessAPES 225, its three kinds of engagement, and what a report states.