Using financial statements to value a business - Miller Kaplan (2024)

The starting point for a business valuation is generally the subject company’s financial statements. Here’s an overview of how historical financial statements can serve as the basis for a valuation professional’s conclusion under the cost, income and market approaches.

Cost (or asset-based) approach

Because the balance sheet identifies a company’s assets and liabilities, it can be a reliable source of financial information, especially for companies that rely heavily on tangible assets (such as manufacturers and real estate holding companies). Under U.S. Generally Accepted Accounting Principles (GAAP), assets are recorded at the lower of cost or market value. So, adjustments may be needed to align an item’s book value with its fair market value.

For example, receivables may need to be adjusted for bad debts. Inventory may include obsolete or unsalable items. And contingent liabilities — such as pending lawsuits, environmental obligations and warranties — also must be accounted for.

Some items may be specifically excluded from a GAAP balance sheet, such as internally developed patents, brands and goodwill. Value derived under the cost approach generally omits intangible value, so this estimate can serve as a useful “floor” for a company’s value. Valuators typically use another technique to arrive at a value estimate that’s inclusive of these intangibles.

Income approach

The income statement and statement of cash flows can provide additional insight into a company’s value (including its intangibles). Under the income approach, expected future cash flows are converted to present value to determine how much investors will pay for a business interest. GAAP earnings may need to be adjusted for a variety of items, such as depreciation rates and market-rate owners’ compensation.

A key ingredient under the income approach is the discount rate used to convert future cash flows to their net present value. Discount rates vary depending on an investment’s perceived risk in the marketplace. Financial statement footnotes can help in the evaluation of a company’s risks.

Market approach

The market approach derives a company’s value primarily from information taken from a company’s income statement and statement of cash flows. Here, pricing multiples (such as price to operating cash flow or price to net income) are calculated based on sales of comparable public stocks or private companies.

When looking for comparables, it’s essential to filter deals using relevant criteria, such as industrial classification codes, size and location. Adjustments may be required to account for differences in financial performance and to arrive at a cash-equivalent value, if comparable transactions include noncash terms and future payouts, such as earnouts or installment payments.

Note of caution

Not all financial statements are created equal. Audited financial statements are considered the gold standard in financial reporting. However, many smaller businesses rely on reviewed, compiled or internally prepared financial statements. In addition, smaller entities may issue cash- or tax-basis statements that don’t conform to GAAP. Differences in financial reporting practices can make it difficult to compare the subject company to peers when assessing risk and return under the income approach or determining pricing multiples based on comparables under the market approach.

It’s important for valuation reports to disclose the level of assurance that’s provided in the financial statements that are used to estimate the value of a business or business interest. Contact us to discuss the various levels of assurance and potential pitfalls of using unaudited financials.

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We highly recommend you confer with your Miller Kaplan advisor to understand your specific situation and how this may impact you.

Using financial statements to value a business - Miller Kaplan (2024)

FAQs

How do you value a company based on financial statements? ›

Tally the value of assets.

Add up the value of everything the business owns, including all equipment and inventory. Subtract any debts or liabilities. The value of the business's balance sheet is at least a starting point for determining the business's worth.

Can you tell what a company is worth from its financial statements? ›

The income statement and statement of cash flows can provide additional insight into a company's value (including its intangibles). Under the income approach, expected future cash flows are converted to present value to determine how much investors will pay for a business interest.

Which financial statement tells the value of a business? ›

Also referred to as the statement of financial position, a company's balance sheet provides information on what the company is worth from a book value perspective. The balance sheet is broken into three categories and provides summations of the company's assets, liabilities, and shareholders' equity on a specific date.

How do I calculate the value of my business? ›

Take your total assets and subtract your total liabilities. This approach makes it easy to trace to the valuation because it's coming directly from your accounting/record keeping. However, because it works like a snapshot of current value it may not take into consideration future revenue or earnings.

How many times profit is a business worth? ›

Generally, a small business is worth 1-2 times its annual profit. However, this number can be higher or lower depending on the circ*mstances. If the business is in a high-growth industry, for example, it may be worth 3-5 times its annual profit.

How do you find the net worth of a company from financial statements? ›

Ans : The formula for calculating a company's net worth is to identify the number of financial assets held by the company. The net total value is calculated by subtracting the asset from the liability. As a result, the formula is: Assets minus liabilities equals net worth.

How much is a business worth with $1 million in sales? ›

The Revenue Multiple (times revenue) Method

A venture that earns $1 million per year in revenue, for example, could have a multiple of 2 or 3 applied to it, resulting in a $2 or $3 million valuation. Another business might earn just $500,000 per year and earn a multiple of 0.5, yielding a valuation of $250,000.

What is the rule of thumb for valuing a business? ›

A common rule of thumb is assigning a business value based on a multiple of its annual EBITDA (earnings before interest, taxes, depreciation, and amortization). The specific multiple used often ranges from 2 to 6 times EBITDA depending on the size, industry, profit margins, and growth prospects.

How much is a company with 10 million in revenue worth? ›

Price is not based on sales, but on earnings (profit). A company that is doing $10M in sales with a traditional 10% profit will be earning $1M before taxes. As a small company that is growing it will sell for a multiple of about 4 X Earnings = $4M.

Why do the financial statements not show the value of the business? ›

Two reasons why the value of a business is not included in the financial statements are: The financial statements are generally based on the company's past recorded transactions. The value of the business will more likely be based on the perceived future transactions.

How to tell if a company is profitable from a balance sheet? ›

The two most important aspects of profitability are income and expenses. By subtracting expenses from income, you can measure your business's profitability.

Does the balance sheet reflect the true value of the business? ›

KEY POINTS. Balance sheets do not show true value of assets. Historical cost is criticized for its inaccuracy since it may not reflect current market valuation. Some of the current assets are valued on an estimated basis, so the balance sheet is not in a position to reflect the true financial position of the business.

How much is a business worth that makes 100k a year? ›

Factors affecting small business valuation

Thus, buyers have to approach the deal as if they are purchasing a job. Businesses where the owner is actively-involved typically sell for 2-3 times the annual earnings of the company. A business that earns $100,000 per year should sell for $200,000-$300,000.

Is there a formula for valuing a company? ›

To accurately ascertain a business's value efficiently, calculate its total liabilities and subtract that figure from the sum of all assets—the resulting number is known as book value. This approach to calculating company worth takes into account both existing assets and any outstanding liabilities.

How much does a business usually sell for? ›

A business will likely sell for two to four times seller's discretionary earnings (SDE)range –the majority selling within the 2 to 3 range. In essence, if the annual cash flow is $200,000, the selling price will likely be between $400,000 and $600,000.

How much is a company worth based on balance sheet? ›

Net Worth in Business

The balance sheet is also known as a net worth statement. The value of a company's equity equals the difference between the value of total assets and total liabilities. Note that the values on a company's balance sheet highlight historical costs or book values, not current market values.

What is the formula for valuation of a company? ›

The valuation of a company based on the revenue is calculated by using the company's total revenue before subtracting operating expenses and multiplying it by an industry multiple. The industry multiple is an average of what companies usually sell for in the given industry.

Which financial statements will tell you how profitable a company is? ›

Statement #1: The income statement

The income statement is read from top to bottom, starting with revenues, sometimes called the "top line." Expenses and costs are subtracted, followed by taxes. The end result is the company's net income—or profit—before paying any dividends.

How do you value a company based on profit and revenue? ›

First, you determine the company's profit or their gross income minus expenses. Once you arrive at an annual profit, you multiply that amount by a multiplier that you determine. The result is the value of the business.

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