Wikipedia makes the rather startling assertion that business value is an informal concept for which there is no consensus on its role in effective decision-making. I say startling, because surveys consistently show that there is a tidal wave of businesses that will change hands in the next few years. If I’m a business owner who plans to retire in, say, 5 years and the sale of the business is hoped to be my nest egg, I would want to have a laser-like focus on business value. I would bet that the business owner who is attuned to value will, over the long run, make better decisions than one who is not.
It is often said that beauty is in the eye of the beholder and so too with value. Business value can be subjective and business valuation is both an art and a science. For example, when valuing a business there are different standards that can be used depending on the purpose of the valuation: fair market value, investment value and intrinsic value, to name a few. There are also a variety of valuation approaches that can be used: the income, market or cost approach. And yet, despite the variety of standards and approaches that can be used, there are some known constants that directly impact the value of most businesses.
So what factors almost always influence business value? There are at least three: net cash flows, growth, and cost of capital. You accountants out there will have recognized that these are the inputs into our good buddy the discounted cash flow model. Thats because the value of any business is the total of the expected future benefits that result from ownership.
We’ll continue this discussion by looking at these important value determinants in subsequent posts . . .
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