As we discussed in the last blog, a business valuation expert will utilize three (3) different approaches to analyze and reach a conclusion on the value of your business – the income approach, the asset approach, and the market approach.
This week we will discuss the “income approach”. Under an income based approach, the business valuator looks at the financials of the business over the course of the past using tax returns, profit and loss statements, balance sheets and “the books” and uses the past history of the business to figure out what net cash flow or profit of the business and then project future earnings and cash flow for that business thereby coming up with a the applicable capitalization rate arising out of this projection of future earnings. Depending on the circumstances of your interest and the business itself, it may also encompass applying certain standard discounts to that capitalization arising such as a minority shareholder discount evidencing a lack of control by the interest holding spouse or lack of marketability for a business in a niche industry. Applying that capitalization rate and any discounts, it arrives at a value for your business as a whole and thereafter your shares or interest in the same.
The benefits of using an income approach is that it is based on the actual past financials of the business itself, making this value much more tailored to the facts and circumstances of your individual business rather than a model based on industry wide or market factors that may not really match up with your particular business. For example, a “Mom and Pop” restaurant may match up with a larger, chain restaurant as far as what they do, what is offered on their menu or in their clientele, but their finances may be extremely different as to costs, income and other relevant financial details – an income approach, unlike a market approach would be beneficial for making the obvious and necessary distinction between those two businesses. On the other hand, it is based largely on past performance for the business in order to reach its conclusions – it does not account for recessions, acts of God such as storm damage or fires, or other circumstances which could seriously impact any actual future earnings or net cash flow.
If you are facing the prospect of a divorce and likely valuation of your business, you need the services of an experienced divorce attorney. If you would like to consult with one of our experienced attorneys in regards to a pending divorce and related business valuation, please call OWENS & PERKINS at480.994.8824 to schedule a free 30 minute consultation.