Valuation Process: A Comprehensive Guide

Valuing a business is not just about number crunching — it's a process that requires careful planning, analysis, and adherence to professional standards. When valuers focus solely on the mathematical aspects, they risk missing critical factors that contribute to the true value of a business.

Weaknesses in the valuation process can lead to confusion and disagreements about the final results. A structured approach is essential for ensuring that all relevant aspects are considered, leading to a credible and defensible valuation.

Following professional standards

The Institute of Chartered Accountants of New Zealand (ICANZ) issued AES-2, which sets out the minimum professional standards for conducting independent valuation engagements. Valuers should consult AES-2 at the outset of a valuation project.

Clause 18 of AES-2 states: "A member must plan the independent business valuation work so that the engagement will be performed in an effective manner." Planning is key to delivering a reliable valuation. The following steps outline a recommended approach to planning and conducting a valuation.

Establishing the basics

Before proceeding, the valuer must establish several fundamental aspects of the valuation, including:

Legal interest: The specific interest in the business being valued, whether the entire business or a part ownership.
Date of valuation: The valuation date is critical, as the same business may have different values at different points in time.
Purpose of appraisal: Understanding the purpose helps determine the appropriate valuation approach and standards.
Going concern or liquidation value: Determine whether the business is valued as a going concern or on a liquidation basis.
Type of valuation: Is it an indicative valuation or a full valuation?
Special requirements: Identify any limitations, special instructions, or requirements specific to the engagement.

Key takeaway: Getting the fundamentals right before diving into analysis prevents costly missteps and ensures the valuation is fit for purpose.

Collection of full information

A credible valuation is underpinned by comprehensive information about the business. This includes historical, operational, and financial data. The valuer must ask numerous questions to gather the required information, including:

Management and organisation structure: Understanding how the business is organised and managed.
Lease details: Reviewing lease agreements and understanding their implications for value.
Products and services: Analysing the range of products and services offered.
Intangible assets: Identifying intangible assets such as brands, domain names, and agencies.
Suppliers and customers: Assessing the spread and concentration of suppliers and customers.
Financial records: Ensuring access to up-to-date financial records.

For a deeper look at what information is needed and how to prepare it, see our guide on gathering information for a business valuation.

Internal analysis and risk assessment

Internal analysis involves evaluating the business's internal environment to assess risks and opportunities. This includes:

Reliance on key personnel: Identifying key personnel and understanding the impact of their potential departure.
Agency loss: Assessing risks related to the separation of ownership and management.
Security of tenure: Evaluating the security of the business's premises or operational facilities.
Personal goodwill: Determining the extent of personal goodwill that is tied to the owner or key individuals.

External analysis, risk and opportunity assessment

External analysis considers factors beyond the business that could impact its value. These include:

Legislative changes: Evaluating the impact of any current or upcoming changes in legislation.
Economic conditions: Understanding the broader economic environment and its effect on the business.
Technological developments: Considering how technology changes might create risks or opportunities.
Competition: Analysing the competitive landscape to identify threats and opportunities.

Historical financial statements, adjustments, and projections

Reviewing the business's historical financial statements is an essential part of the valuation process. The valuer must also make appropriate adjustments to these financials to normalise them. This involves removing one-off or non-recurring items that do not reflect the ongoing operations of the business.

Once the historical data is understood, projections can be made to estimate future performance, which is critical for determining value.

Selecting valuation approaches and methods

The choice of valuation method depends on the type of business and the purpose of the valuation. Common approaches include:

Income approach: Using discounted cash flows (DCF) or capitalisation of earnings to value the business based on its future income potential.
Market approach: Comparing the business to similar businesses that have been sold recently (using comparables from Bizstats).
Asset-based approach: Valuing the business based on the net value of its assets, suitable for asset-heavy businesses.

Key takeaway: No single valuation method is universally correct. Using multiple approaches and reconciling the results leads to a more robust and defensible conclusion.

Valuation conclusion

Once all the analysis is complete, the valuer must reconcile the different methods used and arrive at a well-supported conclusion. This involves judgment, as different methods may yield different values. The final valuation should reflect a balanced consideration of all the information gathered and analysed during the process.

Final thoughts

A structured valuation process helps ensure that valuers do not overlook important details, reducing the risk of arriving at incorrect or misleading conclusions. Following professional standards, gathering comprehensive information, and carefully selecting the appropriate valuation methods are essential for delivering a credible valuation.

Valuers should remember that valuation is as much about qualitative judgment as it is about quantitative analysis. Understanding where the process commonly breaks down can help avoid errors — for more on this, see our post on why valuers get it wrong.

For more insights into the business valuation process, visit Bizstats.