David Anderson is principal of David Anderson & Associates, a Philadelphia forensic accounting firm that provides a full range of business valuation and other forensic accounting services in Philadelphia and the Delaware Valley. This is the second of a five-part series in which Anderson reviews the basics of business valuation.

Knowing how to calculate a value of your business that is accurate and fair is a skill every corporate principal should be familiar with.

“You don’t want to rely on estimates, gut instinct or rumored calculation methods to determine business value,” said David Anderson, principal of David Anderson & Associates, a Philadelphia forensic accounting firm that provides a full range of business valuation and other forensic accounting services in Philadelphia and the Delaware Valley.  “When you need to know the true worth of your business, you need to understand the process.  And you need the expertise of a highly qualified business valuation expert.”

In a recent posting, Anderson covered the first step of business valuation — determining the standard of value.

“The second step in ascertaining a company’s worth,” he said, “is to decide on the premise of value.”

The premise of value is the type of transactional circumstances underlying the business or property being valued, Anderson said, adding that there are four premises of value:

• Going concern value
• Book value
• Liquidation value
• Replacement value.

Going concern value is the most frequently used premise of value. This method assumes the business is operating and producing revenues . . . and will continue to do so.

Book value is the difference between a company’s total assets that have been adjusted for depreciation, depletion and amortization and the amount of total liabilities as listed on the balance sheet.  Assets such as real estate, collectibles and artwork are recorded at historical cost and therefore may be undervalued on the balance sheet.  Intangible assets such as patents, copyrights and trademarks also may be undervalued.

Interestingly, many buy-sell and shareholder agreements use book value to establish share value when a shareholder wishes to sell shares back to the company or when shares are purchased after a shareholder is terminated or dies.  In these cases, disputes often arise when the book value of the shares is significantly less than the going concern value.

Liquidation value is the net amount realized if the business is terminated and the assets are sold individually.  Liquidation value typically results in the lowest of the premises of value, Anderson said.

Replacement value generally is used for specific assets and refers to the current cost of property equivalent to the property being valued.  Replacement value is often used in insurance contracts for calculations involving real estate or tangible personal property and in construction or manufacturing agreements.

“Determining these two crucial steps — the standard of value and the premise of value — will allow a business valuation expert to select the appropriate valuation methodology to decide your company’s worth,” Anderson said.

Over the next several weeks, Anderson will post additional articles on the specific methods business valuation experts use to establish value, the effect non-operating assets have on business valuation and discounts for lack of control and lack of marketability. Coming up next in Part Three, an examination of the steps a business valuation expert sometimes must take to bring a company’s financial statement on an equal footing.

If you require the services of a business valuation expert in Philadelphia or any other forensic accounting services in Philadelphia and the Delaware Valley, please contact the Philadelphia forensic accounting firm of David Anderson & Associates by calling David Anderson at 267-207-3597 or emailing him at david@davidandersonassociates.com.

About David Anderson & Associates

David Anderson & Associates is a Philadelphia forensic accounting firm that provides a full range of forensic accounting services in Philadelphia and the Delaware Valley.  The experienced professionals at David Anderson & Associates provide forensic accounting, business valuation, fraud investigation, litigation support, economic damage analysis, business consulting and outsourced CFO services.  Company principal David Anderson has more than 30 years of experience in financial and operational leadership positions and is a Certified Public Accountant, a Certified Fraud Examiner, a Certified Valuation Analyst and a business valuation expert in Philadelphia.