BUSINESS VALUATION, ACCOUNTING and EQUIPMENT TERMS
The following definitions and explanations come from various resources and are used in the international business valuation, accounting, and equipment industry.. These definitions will facilitate a better understanding between sellers, buyers, accountants, attorneys, appraisers, and all other professionals that serve the business transfer industry.
Accrual Basis Accounting – A method of accounting wherein income and expenses are recognized, within the statements, when the business first acquires the right to receive the income, or the obligation to pay the expense.
Accumulated Depreciation – Total accumulated depreciation reduces the formal accounting value (book value) of assets.
Adjusted Book Value Method – A method within the asset approach whereby all assets and liabilities (including off-balance sheet, intangible, and contingent) are adjusted to their fair market values (NOTE: in Canada on a going concern basis).
Adaptive Firm –An organization that is able to respond to, and adjust to changes in their market, environment or their industry to better position themselves for survival and profitability.
Allocation – The process of distributing an expense to a number of items or areas.
Amortization – Amortization is a method of recovering (deducting) certain capital costs over a fixed period of time. It is similar to the straight-line method of depreciation.
Asset Based Approach – A general way of determining a value indication of a business, Business ownership interest, or security using one or more methods based on the value of the assets net of liabilities.
Assessed Valuation – The taxable value of a property
Benchmark – A benchmark is a standard or guideline used to compare some aspect of a business to some objective or external standard measure.
Benefit Stream – Any level of income, cash flow, or earnings generated by an asset, group of assets, or business enterprise.
BLI – Business listing information (sheet)
Book Value – The value of an asset or group of assets (including a complete business) as stated on the owner’s financial statements of accounting records. This value differs frequently from other types of value for reasons that include tax considerations.
Brand – A name, term, sign, symbol, design, or a combination of all used to uniquely identify a producer’s goods and services and differentiate them from competitors.
Brand Equity –The added value a brand name identity brings to a product or service beyond the functional benefits provided.
Brand Recognition – Positions customer’s relative perceptions of one brand to other competitive alternatives.
Break-Even Analysis – a standard financial analysis that measures general risk for a company by showing the sales level needed to cover both fixed and variable costs.
Break-Even Point – The unit sales volumes or actual sales amounts that a company needs to equal its running expense rate and not lose or make money over a given time period.
Bundling – The practice of marketing two or more product or service items in a single package with one price.
Burden Rate – Refers to personnel burden, the sum of employer costs over and above salaries (including employer taxes, benefits, etc).
Buy-Sell Agreement – An agreement designed to address situations in which one or more of the entrepreneurs wants to sell their interest in the venture
Business Valuation – The act or process of determining the value of a business enterprise or ownership interest therein.
Cannibalization – The undesirable tradeoff where sales of a new product or service decrease sales from existing products or services and minimize or detract from the total revenue contribution of the organization.
Capital Expenditure – The spending on capital assets (also called plant and equipment, or fixed assets, or long-term assets).
Capital Input – It is new money being invested in the business, not as loans or repayment of loans, but as money invested in ownership. This is also money at risk. It will grow in value if the business prospers, and decline in value if the business declines.
Capitalization – A conversion of a single period of economic benefits into value.
Capitalization Rate – Any divisor, usually expressed as a percentage that is used to convert income into value. The divisor used in business valuation, is a rate that would be required to provide a value for a particular type of economic income stream (Cash Flow).
Capitalization Factor – Any multiple or divisor used to convert anticipated economic benefits of a single period into value.
Capitalization of Earnings Method – A method within the income approach whereby economic benefits for a representative single period are converted to value through division by a capitalization rate.
Capitalization Rate – Any divisor (usually expressed as a percentage) used to convert anticipated economic benefits of a single period into value.
Capital Structure – The composition of the invested capital of a business enterprise.
Cash Basis Accounting – A method of accounting wherein income and expenses are recognized, within the statements, when the business receives the income, or pays the expense.
Cash Flow – Profit before income tax, depreciation, interest, owners’ compensation and benefits.
Central-Driving-Force-Model (CDFM) – An entrepreneurial-based model that considers the positives and negatives of three areas of the venture; founder(s), opportunities, and resources.
Channels of Distribution – The system where customers are provided access to an organization’s products or services.
Competitive Entry Wedges – These are strategic competitive advantages and justifications for entering an established market or activity that provides recognizable and known value. The four competitive entry wedges include: 1) New product or service 2) Parallel Competition 3) Franchise Entry 4) Twists
Control – The power to direct the management and policies of a business enterprise.
Control Premium – An amount or percentage by which the pro rata value of a controlling interest exceeds the pro rata value of a non-controlling interest in a business enterprise, to reflect the power of control.
Contingencies – Performance is dependent upon successful outcome of named event. (verification of tax returns)
Contribution – Contribution is frequently expressed as contribution margin for a whole company or across a group or product line, in which case it can be taken as gross margin less sales and marketing expenses. Contribution can have different meanings in different context. When contribution is applied to a product or product line, it means the difference between total sales revenue and total variable costs, or, on a per-unit basis, the difference between unit selling and the unit variable cost and may be expressed in percentage terms (contribution margin) or dollar terms (contribution per unit).
Core Market Strategy – A statement that communicates the predominant reason to buy to a specific target market.
A company may wish to purchase another company that would be synergistic with their goals.
Cost Approach – A general way of determining a value indication of an individual asset by quantifying the amount of money required to replace the future service capability of that asset. These methods can consist of 1) Cost To Create Method (exact) 2) Replacement Value (similar). 3) In Place Market Value (economic depreciation/used). 4) Liquidation Value (forced or orderly disposition) 5) Book Value
Cost of Capital – The expected rate of return that the market requires in order to attract funds to a particular investment.
Discount for Lack of Control – An amount of percentage deducted from the pro rata share of value of 100% of an equity interest in a business to reflect the absence of some or all of the powers of control.
Discount for Lack of Marketability – An amount or percentage deducted from the value of an ownership interest to reflect the relative absence of marketability.
Discount Rate – A rate of return (cost of capital) used to convert a monetary sum, payable or receivable in the future, into present value.
Distinctive Competency – An organization’s strengths or qualities including skills, technologies, or resources that can distinguish it from competitors to provide superior and unique customer value and, hopefully, is difficult to imitate.
Dividends – Money distributed to the owners of a business as profits.
Doing Business As (DBA) – Is a company name, also commonly called a “Fictitious Business Name. When a sole proprietor operates a company using any name except his or her own given name, then the DBA or fictitious business name registration establishes the legal ownership to satisfy banks, local authorities, and customers. So when you start the Acme Manufacturing Company, unless you are named Acme, you need your DBA to open a bank account in that name, pay employees, and do business. You can usually obtain this registration through the county government in most states.
Depletion – is the proportional allocation of the cost of natural resources to the units used up or depleted during the accounting period, (minerals, coal, petroleum, timber, natural gas). In accounting, natural resources are also known as wasting assets. Calculated the same as the units-of-production method of depreciation for plant assets.
Depreciation – In an economic sense, as used in recasting of statements, a loss in value of a fixed asset as a result of wear and tear or obsolescence, which can not be corrected by normal repairs. In accountants’ financial statements, an expense item that permits the original cost to be written off against income over the assets’ cost recovery period, as dictated from time to time by the Internal Revenue Service. (In the context of recasting of financial statements the amount of accumulated depreciation could be much greater than the amount shown on the accountants’ statement).
Dual Distribution – The practice of simultaneously distributing products or services through two or more marketing channels that may or may not compete for similar buyers.
Due Diligence – Process of reviewing a businesses financials and it assets before closing. It includes inventory on hand, furniture, fixtures, equipment, vehicles, distributor or employment agreements, licensees, permits and environmental issues like underground storage tanks. Businesses in different industries have different things that require due diligence.
Discount for Lack of Voting Rights – An amount or percentage deducted from the per share value of a minority interest voting share to reflect the absence of voting rights.
Discount Rate – A rate of return used to convert a monetary sum (or series of monetary sums), payable in the future, into present value.
E 2 Visa – Allows nationals from countries that have trade treaties in effect with the United States to enter the United States for the purpose of developing a business. No INS approval is required for these visas but a substantial investment is required. Factors such as creation of U.S. jobs and potential for future growth are considered in adjudicating these visas. The E-2 visa is available to the principal investor as well as to essential employees; there is no numerical cap on years and it is possible to remain in Treaty Investor status for many years. (Check Status changes may be in effect since 09-11-01).
EBT – Earnings Before Taxes
EBIT – Earnings Before Interest and Taxes.
EBITA – Earnings Before Interest, Taxes, and Amortization. EBITA = Pre Tax Profit + Depreciation + Amortization
EBITD – Earnings Before Interest, Taxes and Depreciation
EBITDA – Earnings Before Interest, Taxes, Depreciation, Amortization.
Economic Benefits – Inflows such as revenues, net income, net cash flows, etc.
Economic Life – The period of time over which a property or fixed asset may generate economic benefits.
Economies of Scale – 1) The benefit that larger production volumes allow fixed costs to be spread over more units lowering the average unit costs and offering a competitive price and margin advantage
Effective Date – The specific point in time as of which the valuator’s opinion of value applies (also referred to as “Valuation Date” or “Appraisal Date”).
EIH – Entrepreneur in Heat describes an entrepreneur that continues to develop new products and services beyond what the business can support and inadvertently may diminish the focus and effectiveness of the activities supporting the company’s primary revenue streams.
Enterprise – A commercial, industrial, service, or investment entity (or combination thereof) pursuing an economic activity.
Equity – The owner’s interest in property after deduction of all liabilities.
Equity Financing – The sales of some portion of ownership in a venture to gain additional capital for start-up.
Equity Net Cash Flows – Those cash flows available to pay out to equity holders (in the form of dividends after funding operations of the business enterprise, making necessary capital, and increasing or decreasing debt financing.
Equity Risk Premium – A rate of return added to a risk-free rate to reflect the additional risk of equity instruments over risk free instruments (a component of the cost of equity capital or equity discount rate).
Escrow – Held by third party until conditions are met.
Escrow Account – Account that is used for deposits on a business purchase, regulated by the state and is a non-interest bearing account.
Excess Earnings – That amount of anticipated economic benefits that exceeds an appropriate rate of return on the value of a selected asset base (often net tangible assets) used to generate those anticipated economic benefits.
Excess Earnings Methods – A specific way of determining a value indication of a business, business ownership interest, or security determined as the sum of a) the value of the assets derived by capitalizing excess earnings and b) the value of the selected asset base. Also frequently used to value intangible assets. See Excess Earnings.
Fair Market Value – The price, expressed in terms of cash equivalents, at which property or business would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arms length in an open and unrestricted markets, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant fact. (Note: In Canada, the term “price” should be replaced with the term “highest price”).
Fair Market Rent – This is a real estate term used to describe the amount of money that a property would lease for if it were available now in a competitive market.
Fairness Opinion – An opinion as to whether of not the consideration in a transaction is fair from a financial point of view.
Financial Statements – A series of accounting reports summarizing a company’s financial data compiled from business activity over a period of time.
Financial Risk – The degree of uncertainty of realizing expected future returns of the business resulting from financial leverage.
Fiscal Year – Standard accounting practice allows the accounting year to begin in any month. Fiscal years are numbered according to the year in which they end, For example, a fiscal year ending in February of 2003 is Fiscal 2003, even though most of the year takes place in 2002.
Five Forces Model A model that considers these forces as they impact an industry and the overall competitive climate: 1) Risk of entry by potential competitors 2) Bargaining power of suppliers 3) Bargaining power of buyers 4) Threat of substitute products 5) Rivalry among established firms.
Forced Liquidation Value – Liquidation Value, at which the asset or assets are sold as quickly as possible, such as at an auction.
Fractional Interest – Any interest that is less than 100%. Always valued as a going concern basis assuming continuation for profits.
Future Value Projections – The process of projecting the future value of a business and/or an investment in the business. It typically considers an expected rate of return, inflation, and the period of time to assess future value.
Going Concern – An ongoing operating business enterprise.
Going Concern Value – The value of a business enterprise that is expected to continue to operate into the future. The intangible elements of Going Concern Value result from factors such as having a trained work force, an operational plant, and the necessary licenses, systems, and procedures in place.
Goodwill Value – 1)An intangible asset arising as a result of name, reputation, customer loyalty, location, products, and similar factors not separately identified. 2) When a company purchases another company for more than the value of its assets–which is quite common–the difference is recoded as an asset named “Goodwill.” For example, if one business buys another business for $1 million then it needs to show the $1 million spent as an asset. If there are only $500 thousand in real assets, the accounting result should be $500,000 in real assets purchased and another $500,000 in “Goodwill.”
Harvesting – is most often referring to selling a business or product line, as when a company sells a product line or division or a family sells a business. Harvesting is also occasionally used to refer to sales of a product or product line towards the end of a product life cycle.
Income (Income-Based) Approach – A general way of determining a value indication of a business, business ownership interest, security, or intangible asset using one or more methods that convert anticipated economic benefits into a present single amount. The income approach considers a business as though it were a money machine whose purpose is to produce money for its owners. This approach best encompasses the principle of substitution, that is, the value of a thing tends to be determined by the cost of acquiring an equally desirable substitute.
Intangible Assets – Non-physical assets such as brand names, backlog of orders, computer software, copy rights, distributorship, employment contracts, engineering drawings and specifications, favorable financing, film rights, formulas, franchises, film and record libraries, goodwill, insurance agency expirations, leases, license agreements, loan portfolios, trademarks, patents, equities, easement rights, mailing lists, Medical Records, mineral rights, non-compete agreements, royalty agreements, product lines, proprietary technology, publishing rights, purchase contracts, service contracts, trade names, securities, subscribers, water rights and contracts (as distinguished from physical assets) that grant rights and privileges, and have value for the owner.
Intensive Distribution –A distribution strategy whereby a producer attempts to sell its products or services in as many retail outlets as possible within a geographical area without exclusivity.
Invested Capital – The sum of equity and debt in a business enterprise. Debt is typically a) long-term liabilities or b) the sum of short-term interest-bearing debt and long-term liabilities. When the term is used, it should be supplemented by a definition of exactly what it means in the give valuation context.
Invested Capital Net Cash Flows – Those cash flows available to pay out to equity holders (in the form of dividends) and debt investors (in the form of principal and interest) after funding operation of the business enterprise and making necessary capital investments.
Investment Risk – The degree of uncertainty as to the realization of expected returns.
Entrepreneurship – Entrepreneurial-based activities within a corporation that receive organizational support and resources commitments for the purpose of an innovative new business experience within the organization itself.
Insurable Value – The portion of the value of an asset of asset group that is acknowledged or recognized under the provision of an applicable insurance policy.
Inventory – Goods that a company has in its possession at any given time. A stockpile of unsold products.
Investment Value – Value as determined or estimated in accordance with the investment value (income approach). The value of an investment or business that arises from its presumed ability to produce a profit or return for its owner.
Key Person Discount – An amount or percentage deducted from the value of an ownership interest to reflect the reduction in value resulting from the actual or potential loss of a key person in a business enterprise.
Letter of Intent – Non-binding intent to purchase and intent to sell (unless a better offer comes along).
Leveraged Buy-Out (LBO) – A type of purchase of a business that relies heavily on the venture’s cash receipts with expectations of positive cash flow continuing based on historical or other performance indicators.
Liquidity – The ability to quickly convert property to cash or to pay a liability.
Liquidation Value – The (estimated proceeds), net after provisions for applicable liabilities, if any, that would result from the sale of an asset or group of assets, if sold individually and not as part of the business enterprise of which they were originally a part. Sale may involve either forced liquidation or orderly disposal, with the amount of the net proceeds likely different for the two situations.
Market–Based Approach – A general way of determining a value of indication of a business, business ownership interest, security, or intangible asset by using one or more methods that compare the subject to similar businesses, business ownership interests, securities, or intangible assets that have been sold.
Market Multiple – The market value of a company’s stock or invested capital divided by a company measure (such as economic benefits, number of customers).
Marketability – The ability to quickly convert property to cash at minimal cost.
Majority Owner (s) – Owners of a majority of the stock in a corporation.
Maker – The person signing or giving a promissory note.
Markup – Amount added to cost to arrive at retail price (expenses plus desired profit).
Market Segmentation – The categorization of potential buyers into groups based on common characteristics such as age, gender, income, and geography or other attributes relating to purchase or consumption behavior.
Minority Discount – A discount for lack of control applicable to a minority interest.
Minority Interest – An ownership interest less than 50% of the voting interest in a business enterprise.
Moving Weighted Average – Is a statistical method to forecast the future based on past results.
Net Book Value – With respect to a business enterprise, the difference between total assets (net accumulated depreciation, depletion, and amortization) and total liabilities as they appear on the balance sheet (synonymous with Shareholder’s Equity). With respect to a specific asset, the capitalized cost less accumulated amortization or depreciation as it appears on the books of account of the business enterprise.
Net Tangible Asset Value – the value of the business enterprise’s tangible assets (excluding excess assets and non-operating assets) minus the value of its liabilities.
Net Worth- Total assets minus total liabilities, as reflected by the balance sheet. Synonymous with, net book value or owner’s equity.
Non-Disclosure Agreement (NDA) – Agreement from a buyer that he/she will not divulge information about a business for sale, talk to employees, customers, competitors, bankers, or suppliers of that business or anyone not directly involved in the sale (attorney, accountant). Great financial harm can befall an owner as a result of disclosing private financial information about a company or individual that has a business for sale. (Bankers could call a loan due or deny a loan request if they found out about an impending sale). A party revealing such information can be held accountable for damages in a court of law. If proven, they themselves or a person they told caused harm, both could be held liable. Remember the old wartime phrase “loose lips sinks ships” applies to businesses also.
Non-Operating Assets – Assets not necessary to ongoing operations of the business enterprise. (Note: In Canada, the term is “Redundant Assets.)
Non-recurring Item – Income or expense arising from a cause not likely to exist in future years.
Orderly Liquidation Value- Liquidation value at which the asset or assets are sold over a reasonable period of time to maximize proceeds received.
Premise of Value– An assumption regarding the most likely set of transactional circumstances that may be applicable to the subject valuation; e.g. going concern, liquidation.
Perquisites (Perks) – Special additional benefits received because of position. In closely-held businesses these are often a result of the business’ ability to pay them, than a result of market rate compensation for the services provided to the business (Abbreviation – perks) e.g. company paid vehicles, insurance, travel, memberships, salary in excess of market rate, bonuses, etc.
Present Value – Present Value is the value in today’s dollars assigned to an amount of money in the future, based on some estimate rate-of-return over the long-term. Stated another way, an investment that earns 10% per year and can be redeemed for $1000 in 5 years would have a present value of $620. In other words, $620 today is worth $1000 in 5 years.
Principle of Alternatives – In any contemplated transaction, each party has alternatives to consummating the transaction. 1) Can buy another existing similar business 2) Can start an equivalent business from scratch 3) Can make an investment is some completely different type of investment 4) Can and most frequently do nothing.
Principle of Future Benefits – Economic value reflects anticipated future benefits. All values are anticipation of the future. Past performance and present status offers important insights to what a business is likely to do in the future, but it is the anticipated future performance of a business that gives it economic value.
Principle of Substitution – The value of a thing tends to be determined by the cost of acquiring an equally desirable substitute. An “equally desirable substitute” may take on a somewhat different meaning, and the search for such substitutes, as a basis for comparison will not necessarily be limited to other property of similar kind, function, or geographic location.
Pro Forma Income Statement – In this context means projected. An income statement is the same as a profit and loss statement, a financial statement that shows sales, cost of sales, gross margin, operating expenses, and profits.
Product Development Cost – Expenses incurred in development of new products (salaries, laboratory equipment, test equipment, prototypes, research and development, etc.).
Prorate – To spread equally over a period of time.
Price To Earnings Multiple – The price of a share of stock divided by its earnings per share.
Rate of Return – An amount of income (loss) and/or change in value realized or anticipated on an investment, expressed as a percentage of that investment.
Recasting or Normalizing Financial Statements – A process used to determine a company’s true cash flow available to a new owner by normalizing or recasting the owner’s salary and benefits, eliminate non-recurring expenses and eliminate or adjust expenses not present under a new owner. In addition, it is often necessary to recast the balance sheet to reflect assets at fair market value rather than book value; adjust inventory and qualify off balance sheet or undervalued assets such as trademarks, copyrights, patents, and intellectual property. Therefore, recasting is merely a series of these adjustments to earnings (the income statement) and equity (the balance sheet) that reveal the true earning capacity of the business a new purchaser can assume.
Rent Adjustment – 1.For valuation purposes, it is a dollar amount added to, or subtracted from the Seller’s Discretionary Cash Flow (aka: SDCF, SDE, SDC,) thereby adjusting the cash flow of a business to reflect the “fair market rent” of the land and building the business occupies and in turn, show the adjusted cash flow a new owner will have after buying the business.
Replacement Value – Is1). The value of a business, asset or asset group, as determined by the replacement cost approach. 2). The value as determined on the basis of the estimated cost of replacing the assets in question with other items of like kind and condition, and capable of producing equivalent benefits (results) for the user. Replacement value can either be depreciated replacement value or replacement value new.
Report Date – The date conclusions are transmitted to the client.
Replacement Cost New – The current cost of a similar new property having the nearest equivalent utility to the property being valued.
Reproduction Cost New – The current cost of identical new property.
Risk-Free Rate – The rate of return available in the market on an investment free of default risk.
Risk Premium – A rate of return in addition to a risk-free rate to compensate the investor for accepting risk.
Rule of Thumb – A mathematical relationship between or among variables based on experience, observation, hearsay, or a combination of these, usually applicable to a specific industry.
Required Rate of Return – The minimum rate of return acceptable by investors before they will commit money to an investment at a given level of risk.
Rule of Thumb – A mathematical formula developed from the relationship between price and certain variables based on experience, observation, hearsay, or a combination of these; usually industry specific.
SDE– (Seller’s Discretionary Earnings) SDE is also known as DE, SDC, FCF, Owners Benefit, etc.
SDE = Pre Tax Profit + Owner’s Salary & Benefits + Depreciation + Amortization
Service Business – Firms dealing in non-merchandising activities
Situational Analysis – The assessment of a company to determine the probability of what has happened or will happen.
Slotting Allowance – Payments to businesses for acquiring and maintaining shelf space.
Special Interest Purchasers– Acquirers who believe they can enjoy post acquisition economies of scale, synergies, or strategic advantages by combining the acquired business interest with their own.
Standard of Value – The identification of the type of value being used in a specific engagement; e.g. fair market value, fair value, investment value.
Success Factors – Primary success factors include considerations regarding: 1). The choice of business based on the status of the market 2). Education and experience 3). People and collaboration 4). Creativity and innovation versus business skills and networks 5). Incubation potential 6). Leveraging available resources 7). Management practices.
Sunk Cost – Past expenditures for a given activity that are typically irrelevant in whole or in part to future decisions. The “sunk cost fallacy” is an attempt to recoup spent dollars by spending still more dollars in the future.
Sustaining Capital Reinvestment– The periodic capital outlay required to maintain operations at existing levels, net of the tax shield available from such outlays
Tangible Assets – Physical assets (such as cash, accounts receivable, inventory, property, plant and equipment, etc.)
Target Market – A defined segment of the market that is the strategic focus of a business or a marketing plan.
Taxable Income – The gross income minus both exemptions and personal deductions.
Turnover – The rate at which an asset is replaced within a given period of time.
UCC – Uniform Commercial Code
USPAP – Uniform Standards of Professional Appraisal Practice are the guidelines that dictate the competency and ethical requirements the appraiser is expected to uphold.
Value in Use – The value of an economic good to its owner/user is based on the production (privacies; utility or amenity form) of the economic good to a specific individual. This is a subjective value and may not reflect market value.
Valuation – The term is used most often for discussions of sale or purchase of a company. It is the act or process of determining the value of a business, business ownership interest, security, or intangible asset. Used as a noun, valuation is what a business is worth, as in “this company’s valuation is $10 million. This would mean that a company is valued at $10 million, or worth $10 million.
Valuation Approach – A general way of determining a value indication of a business, business ownership interest, security, or intangible asset using one or more valuation methods.
Valuation Method – Within approaches, a specific way to determine value.
Working Capital –The excess of the value of the current assets over the value of the current liabilities.