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Dear readers,

We continue the excellent article by Alina Niculita, CFA, ASA. I was about to write a post on the same topic, and she summed it up perfectly. Click here for Alina’s other articles. This post first appeared in the Portland Business Journal on July 12th, 2019.

It’s impossible to value “blue sky”

Business valuation is sometimes perceived as more of an art than a science, especially when the business subject to valuation has more “blue sky” compared to hard assets. “Blue sky” is another somewhat old-fashioned yet very suggestive word for goodwill and intangible assets, and it represents the value of the business in excess of the company’s tangible assets such as cash, inventory, and fixed assets.

Most businesses have some “blue sky” in their total value, some more than others. Business owners looking to sell their business are worried about how “blue sky” is going to be valued, as it is not only intangible, but there is no record of it on any of the financial statements.

The simple answer is that when businesses are valued based on their earnings and cash flows, the valuation already includes the value of goodwill and intangible assets.

I can get a business valuation from an online calculator

If you have read so far, you’ve learned that business value can include tangible value, intangible value, and goodwill. Goodwill is the intangible asset arising as a result of name, reputation, customer loyalty, location, products, and similar factors. Goodwill can further be categorized as business goodwill and personal goodwill. Personal goodwill exists in the case when value is traced to the personal characteristics of an individual involved in the business. Separating the personal goodwill value from the business value is often done for tax purposes or asset division in divorce.

Business value = tangible value + intangible value + business goodwill + personal goodwill

Although the end result of a business valuation is necessarily a number, the process is complex, and many qualitative issues and judgement go into the valuation process. For instance, sometimes the financial statements of the businesses need to be adjusted, or normalized, before they can be used in the appraisal, and often the adjustments require the appraiser’s judgement, or even the use of forensic accounting techniques, and neither can be achieved using an “online calculator.”

Any CPA can value my business as long as she has experience in my industry

Both of the above assumptions are false. Most CPAs are involved in non-valuation matters such as taxation or audit. While there are indeed CPAs that are trained to value businesses, they usually have additional specialty credentials in business valuation. Business valuation credentials to look for include:

  • ASA – American Society of Appraisers.
  • ABV – Accredited in Business Valuation.
  • CVA – Certified Valuation Analyst.

Finally, business appraisers typically do not specialize by industry; instead, business appraisers study the unique characteristics of the industry, if any, as part of the assignment. Business appraisers can acquire industry knowledge from industry reports, trade associations, and industry experts.