In my earlier post, I made a remark about the need to have the right understanding and knowledge of how valuing your business helps you, as business owners understand the financial worth of your business.

You will need to make educated strategic decisions that will impact your company’s future.

To put my point across in a light-hearted way, here’s a simple analogy:

A guy goes to a mathematician and asks him how much is 2 plus 2. The mathematician explains that there are so many different mathematical systems, that he can’t possibly answer that question without lecturing for at least an hour about the philosophical underpinnings of mathematics.

The guy next goes to an accountant to ask how much 2 + 2 equals. The accountant takes out his spreadsheet does the calculation, and informs him that using generally accepted accounting principles, 2 + 2 equals exactly 4.

Next stop is a lawyer’s office. The guy asks the lawyer the same question — how much is 2 plus 2. The lawyer looks around for a bit, pulls down the window shades and closes the door. Then he asks in a whispered tone: “How much do you want it to be?”

While this is a story created to make fun of lawyers (I’m not a lawyer, but I have many lawyer friends who always appreciated lawyer jokes), there’s a basic truth about valuing businesses embedded in the story. There are literally hundreds of ways to value a business but there is no right way. Ultimately the marketplace will value a company.

Still, many business owners hold off on business appraisals due to some popular myths – here are the top 3 common myths:

1. My accountant, financial planner, or lawyer can conduct my business valuation

Many of these professionals may not have with the skill, qualifications, or experience to conduct a business valuation accurately. If these individuals do have the proper credentials for conducting a valuation, there is still a conflict of interest as they have an on-going interest in the business after the valuation is completed.

2. Conducting a business valuation only when a business is ready to be sold

Business valuations are required when selling your business or as a part of the due diligence process for a lender, but this isn’t the only time a business valuation is needed. If a valuation has never been performed on the company, potential business issues have likely been overlooked.

A business valuation will help you understand the realistic range of offers you will receive for your company. Without conducting business valuations in advance, there is little time to make adjustments and improve the value of the company.

Market, economic, industry, and internal operating characteristics of the business will change over time, relying on an appraisal from over a year ago will be misleading.

To address critical business issues, regular valuations of the business are needed.

3. A local competitor sold his business for three times revenue six months ago; my business is worth at least this much

Depending on your industry, the market can fluctuate annually, monthly, or even daily – so what happened six months ago is not relevant to what the business is worth today.

The worth of a business today, depends on three factors:

  • How much cash it generates today
  • Expected growth in cash in the foreseeable future
  • The return buyers require on their investment in your business

How do you value a business based on the future, given that you can’t predict the future? There are ways to approach the problem, but you need to buy “teh tarek” for me to help you out. 🙂

For now, our point is simpler. Don’t fall into the fallacy of thinking that the value of a business is based on its past alone.

Don’t ignore financial statements. They’re important for a lot of reasons.

But, consider whether their greatest importance may be based on the information they can provide about the future.

To borrow some wisdom from Warren Buffet:

“If past history was all there was to the game, the richest people would be librarians.”