Value Blog

There are terms that are frequently used in valuation that have specific meanings.  A group of the appraisal organizations got together and created a glossary defining various terms, the International Glossary of Business Valuation Terms.  Definitions below are taken from the Glossary.

An appraisal is the same as a valuation, which is defined as “the act or process of determining the value of a business, business ownership interest, security or intangible asset.”

The three approaches to valuation are the asset approach, the income approach and the market approach.  Within each approach are various methodologies used in the process of business valuation.

The asset approach is “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.”

The income approach is “a general way of determining a value indication of a business, business ownership interest, security or intangible asset using one or more methods that covert anticipated economic benefits into a present single amount.”

The market approach is “a general way of determining a value 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.”

Discounted cash flow method is “a method within the income approach whereby the present value of expected economic benefits is calculated using a discount rate.”

Discount rate is “a rate of return used to covert a future monetary sum into a present value.” The discount rate converts future net income, earnings or cash flow to a present value.  The rate is used in a formula which takes into consideration the point in time in the future when the benefit is expected to be received.

Capitalization rate or cap rate is “any divisor (usually expressed as a percentage) used to convert anticipated economic benefits of a single period into value.”  In simple terms is a rate that is divided in an estimate of net income, earnings or cash flow for a single period to arrive at a value of a business or business interest under the income approach.  The higher the rate, the lower the value.

A multiple is “the inverse of a capitalization rate.”

These definitions are a start to understanding the terminology used by appraisers.  In future postings I will discuss the application of different approaches and methodology.

© 2009 Florida Business Valuation Group