Ways businesses are valued | Business Appraisal

iSide by side

The approaches, compared

The ATO describes three internationally defined approaches. business.gov.au, writing for owners, lists five common methods. They map onto each other like this.

Approaches from the ATO’s guide; methods from business.gov.au.
Approach	The question it asks	business.gov.au’s matching methods	Where it gets hard
Market	What have comparable assets actually sold for, or been offered at?	Current market values.	The ATO lists poorly chosen comparables among the issues it commonly sees.
Income	What income or cash flows can the business be expected to generate?	Return on investment; future profit.	Assumptions. The ATO flags unsupported adjustments to discount rates and capitalisation multiples, and proxies based on historical performance.
Cost	What would it cost to replicate, in similar condition, at the valuation date?	Business asset value; cost of starting from scratch.	Intangibles. Goodwill is hard to calculate and gives different results by method.

Inside each approach sit particular methods. For the income approach, the ATO names the discounted cash flow method and the capitalisation of earnings method, and says the valuer must choose the most appropriate method for the asset.

iiMarket

Looking at the market

The market approach compares the business with similar ones in actual transactions, and with asking prices of those currently available. business.gov.au says comparing a business with similar businesses on the market or recently sold is not a formal valuation, but can give an idea of a market price.

It also notes that industries usually come up with their own rules and formulas for valuing a business, so knowing your own industry’s conventions matters.

iiiIncome

Looking at income

business.gov.au calls future profit the biggest source of value for a buyer or investor, and suggests estimating it from trends in the business’s own finances over past years, and in similar businesses.

Its simplest income tool is return on investment, which uses net profit:

ROI = (net annual profit ÷ selling price) × 100

The formula can be run either way: from a price to see the return it implies, or from a chosen return to see the price it implies. Either way, the answer is only as good as the profit figure that goes into it. Folio 3 looks at that figure line by line.

ivAssets and cost

Looking at assets and cost

The asset method works out the difference between what the business owns and what it owes. business.gov.au says to count both tangible assets, like tools, equipment and property, and intangible ones, like intellectual property, brands and goodwill, and to allow for depreciation. Its example: a computer bought three years ago for $1,000 no longer counts at $1,000.

The cost-from-scratch method estimates what it would take to build a similar business in today’s market: stock, equipment, licences and permits, staff, product development, marketing, premises and an online presence.

vCross-check

Why one approach is rarely the whole answer

International valuation standards recommend considering more than one approach. For tax, the ATO recommends that, where possible, a secondary or cross-check method supports the estimate from the primary one, and that a report explains why the chosen method suits the asset.

If a valuation ends in a range, the ATO expects an explanation of why the particular figure in that range was adopted. The ATO’s full guide lists the other problems it commonly finds, from inappropriate averaging to inputs nobody verified.