The purpose of a formal appraisal of a business is to estimate the value of the business, usually for the purposes of insurance coverage or for the sale or purchase of the business. Although an appraisal uses a great deal of calculations and objective research, it is still an estimate. Appraisal is an applied art and not a science. However, all legitimate appraisals use standard and accepted techniques and methods in determining that estimate of value.
The asset method, also known as the cost method, examines the assets of the subject business to determine the value estimate. In other words, this method basically states that the value of the business is its assets. This method would be particularly significant for a business that is closed down and being liquidated. Even a going concern has assets that are worth something, especially if the business owns the real estate it occupies and uses. However, this all considers tangible assets, and a business appraisal must also consider intangible assets.
This method concentrates on the main purpose of the business, which is the income it generates through its operation. Here the appraisal heavily utilizes information and techniques from accounting and finance. Detailed discovery and analysis of various streams of income and types of expenses are performed. Projections of future income and expenses are also taken into account. The income method basically says that the value of the business is the current value of its present and future net incomes.
Also known as the comparable method, the market comparison method is the most well known because this technique is relied on for the appraisal of residential real estate. This method treats the business as an object available in the marketplace for purchase and sale. It assumes that a reasonable person will not pay more for that object than a closely similar object available in that marketplace. This method relies on finding closely similar or comparable businesses in the marketplace that recently were sold. While this is fairly simple for homes, it often is not for a business.
In the overall appraisal analysis, most of the data used is objective and tangible. However, a business valuation must also include data that is intangible and therefore somewhat subjective, especially regarding the business assets. The intangible asset known as goodwill is very important. Issues such as how positive is the reputation of the business and its owners or how well known and respected is the store or its products are examined and valuated. The larger and more positive is the goodwill, the higher will be the estimate of value. The converse is also true.