business valuation - glossary of terms

Business Valuation

Glossary of Terms

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AccretionThe growth of a company or other asset via internal expansion or acquisition.

Adjusted Working CapitalWorking Capital excluding all debt in current liabilities. Also known as debt free working capital.

Asset Based ApproachA method of determining the value of a business’s assets and/or equity interest using one or more methods based directly on the market value of the assets or the business less liabilities.

Asset Based LendingA type of financing, commonly found in leveraged buyouts, based on a percentage of some value (book, liquidation, market, auction) of an asset. Asset based lenders typically analyze a target company’s viability as a going concern and its ability to service debt from cash flow.



Base YearA business’ current fiscal year. If complete financial statements are not available for the current year, sales and income are projected based on the year-to-date results and expectations of management.

Book ValueThe capitalized cost of an asset less accumulated depreciation, depletion or amortization as it appears on the books of account of the enterprise. A business enterprise’s book value also is the difference between total assets (net of depreciation, depletion and amortization) and total liabilities of an enterprise as they appear on the balance sheet. Book value also is referred to as net book value, net worth and shareholder’s equity.

Book Value of Invested CapitalThe total sum of the book value of debt and equity as presented on a business’ balance sheet.



Business Valuation or Business AppraisalThe economic value of a business or enterprise. Business valuations are conducted for a variety of purposes, including: strategic business planning; lending requirements; buying a business; selling a business; strategic estate or other tax planning; ESOPs and other employee benefit plans; executive compensation benchmarking; taking a company public; buy-sell agreements; marital, partnership, and corporate dissolutions; and bankruptcy reorganizations.

Capital StructureA business entity’s invested capital composition.

CapitalizationThe capital structure of a company. Also: an accounting exercise that converts historic or projected income into value OR an accounting exercise that recognizes an expenditure as a capital asset to be depreciated over time rather than a period expense.



Capitalization RateTypically a percentage divisor used to convert income into value.

Capitalizing Net IncomeDetermining a company’s value by dividing the net income by the required Return on Investment (ROI).

Cash FlowCash flow is used in performing the discounted cash flow analysis. Cash flow typically is defined as the excess of sources of cash over uses of cash.

Cash Flow LendingUnsecured lending based on the timing and certainty of the borrower’s cash flow.

Cash Flow StatementAn Analysis of operating, investing and financing changes that affect the cash account during an accounting period.



Contingent LiabilitiesPossible liabilities footnoted in financial statements. Examples include: lawsuits pending, involvement in a scam, penalties from purchase commitments, and warranties or guaranties without historical basis to assess possible obligation.

Debt Free Cash FlowA business’ debt free net income plus depreciation less provisions for capital expenditures and working capital.

Debt Free Net IncomeA business’ income presented as if the company had no debt.

Depreciation and AmortizationA reduction in a capital account of the value of an asset over a period of time.

Discount RateA rate of return applied to convert a future payment, monetary sum, or receivable into present value.



Discounted Cash Flow ValueThe present value of future earnings taken out to infinity and discounted at a rate that approximates the risk.

EBITEarnings before interest and taxes.

EBITDAEarnings before interest, taxes, depreciation, and amortization.

Economic LifeThe period of time during which tangible (real estate, equipment, etc.) and intangible (goodwill, R&D, etc.) property may be profitably used.

Employee Stock Ownership Plan (ESOP)A defined contribution plan that allows employees to purchase equity in their employer rm. ESOPs often present opportunities for companies to raise new capital or finance a leveraged buyout.



Evaluation (Valuation) ReportCritical financial document that defines and supports business’ fair market value.

Exit PlanA strategic plan designed around the personal and business objectives of an individual or group of individual owners or investors in a company.

FASBFinancial Accounting Standards Board. This Board issues rulings that govern how accounting reports are prepared.

Fair Market ValueThe total expected consideration value for a business sale between a willing buyer and a willing seller.

Financial BuyerA type of buyer who is primarily interested in the company’s financial return on his investment, rather than investing for a strategic or synergistic reason.



Free Cash FlowCash available for distribution after taxes, but before the effects of financing. Calculated as debt-free net income plus depreciation less expenditures required for working capital and capital items adjusted to remove effects of financing.

Going Concern ValueThe company’s gross value as an operating business. This value may be greater, or less than the liquidation value.

Goodwill or Intangible ValueAssumed value that generates sales revenue in a business, and adds value to its assets. It is the extra value by which the selling price exceeds the fair market value of the company’s operating assets.



ImpairmentBased on Statements 141 and 142 of FASB (Financial Accounting Standards Board), when the goodwill values shown on a company’s balance sheet are exaggerated or overestimated compared with their fair value, impairment occurs. According to FASB 142, businesses must test for impairment annually, and in between annual tests if an event or circumstances change that could reduce the fair value of assets, below their carrying value.

Income ApproachDetermines the value of a business, business ownership interest or security using one or more methods wherein a value is determined based on anticipated benefits, such as the revenue obtained from renting out a property versus investing the purchase price of that property in ventures.

Intangible (Hidden) AssetsAssets of the company that are non-physical, unlisted on the balance sheet, yet have value, such as proprietary software, patents, heavily depreciated fixed assets, strong contractual relationships and an experienced workforce.



Internal Rate of ReturnThe rate of growth an investment is expected to yield; the discount rate used that makes the net present value of cash inflows and outflows equal to zero, thereby indicating that the future cash flows on the investment equal the cost of the investment.

Invested CapitalBook Value of Invested Capital (BVIC) – The sum of a company’s debt, stock, and retained earnings as it appears in the balance sheet. Market Value of Invested Capital (MVIC) – The sum of a company’s debt, stock, and retained earnings, and the market value of equity in an enterprise at a point in time. The value of invested capital is equal to the value of the operating business enterprise.

IRS Revenue Ruling 59-60IRS guidance documents that outline and review in general the approach, methods and factors to be considered in valuing shares of the capital stock of closely held corporations for estate tax and gift tax purposes.



Letter StockShares not registered with the Securities and Exchange Commission (SEC) that are issued without underwriting.

Leveraged Valuation ApproachThe value of the business as determine in general. Like a leveraged buyout of a business, it uses various financial instruments to increase the valuation of a company. As in a typical buyout transaction, the corresponding deal structure and valuation are driven by: 1) the leveragability of the target company’s balance sheet and cash flows, 2) the coverage ratios required by senior lenders, and 3) the internal rate of return sought by the equity investor(s).

Liquidation ValueThe cash value of a company’s individual asset (not as part of an ongoing business enterprise), with the corresponding adjustment in value given for the period it is in the marketplace.



LiquidityThe ability to convert a company’s asset to cash quickly, and meet immediate and short-term obligations.

Market ApproachThe method of determining the value of a business, business ownership interest, or security using one or more methods that compare the subject to what has been sold similarly, adjusting for differences in quality, quantity, or size.

Market CapitalizationRepresents the aggregate value of an entire company, calculated by multiplying the number of shares outstanding by the price per share.

Market MultipleThe value derived from dividing the market value of a company’s stock or invested capital, over a company’s adopted factor from its financial, operating or physical data. It can also be generated by using comparable companies’ financial, operating or physical data.



Net AssetsTotal assets minus total liabilities of the company.

Net Cash FlowA measure of the company’s financial health, it is the cash equivalent after deducting taxes and the effects of financing; calculated as net income plus depreciation less expenditure required for working capital, capital items and debt repayment (See also cash flow).

Net IncomeRevenue less all costs, including interest, taxes, depreciation, and amortization.

Net Present ValueThe current value of an investment derived by comparing its current value to its future value, taking inflation and returns into consideration.



Non-Operating AssetsAssets that are not essential to the ongoing operations of the business yet are shown on the company’s balance sheet; these “extra” assets may still generate income or provide a return on investment, though. These would be recast when valuing the business.

Normal Working CapitalThe amount of cash available for the company to meet its day-to-day operations and short-term obligations. Computed as the average of current assets (which include a normal amount of necessary cash) minus current liabilities on a monthly basis over the most recent twelve months.

Present ValueThe current value of a future payment, or stream of payments, discounted at an appropriate interest rate.

Pre-tax IncomeThe income earned by a business before federal or state income taxes are applied.



Private EquityA source of equity capital consisting of investors and funds used for direct investments to private companies, or for acquisition of an asset that cannot be traded on a public stock market. The capital is raised from individual or institutional investors. In order to grow the company it is investing in and make it more valuable, a private equity firm would be involved in the management of that company. Types of private equity investments include: leveraged buyout, venture capital, growth capital, angel investing and mezzanine capital.

Product/Service ExtensionAn additional product or service that can be sold in the acquirer’s current geographic areas and/or to current customers.



Pro Forma StatementsFinancial statements that emphasize either current or projected figures, which incorporates one or more hypothetical data; Pro forma statements are generally supported by a documented, reasonable projection of the business enterprise.

Quick RatioA measure of a company’s liquidity and how this can pay o short-term obligations; Equals current assets minus inventories, and then divided by current liabilities.

Rate of ReturnThe amount gained or lost on an investment over a period of time, expressed as a percentage of that investment.

Recast (Adjusted) Book ValueThe adjustment in book value after one or more asset or liability amounts are added, deleted or modified from the respective book amounts.



Recast (Adjusted) EarningsThe earnings after adjusting historical financial statements that eliminates certain expenses through cost-saving measures.

RecastingAdjusting the data in a company’s historical financial statements to eliminate items that are unrelated to the ongoing business operation, and which reflect the financial benefits of owning the business. Recasting presents an encouraging picture of the company as being operated by a management whose goal is to maximize profit. It also allows for meaningful comparisons with other investment opportunities.

Replacement Cost NewThe current cost of replacing an existing item with one which is similar, and of equal utility, to it.



Return on Equity (ROE)The return on reinvested earnings to yield additional earnings. It is expressed as a percentage, and is equivalent to a fiscal year’s after-tax income divided by book value.

Return on Investment (ROI)The income that an investment yields in a year. It measures how effectively a company uses its capital to earn profits.

SWOT AnalysisThe analysis of a company’s Strengths, Weaknesses, Opportunities and Threats; A SWOT analysis is essential in understanding how competitive a target company is, and its long-term growth potential.

Situation AnalysisAn evaluation of a company’s past and current data, and its effect on the company’s future; A situation analysis is oftentimes a reference point for the future growth potential of the business.



Tangible AssetsAssets that exist physically, such as cash, real estate, and equipment.

Terminal ValueThe value of an item at the end of a specific period; This is sometimes referred to as residual value.

Valuation ApproachThe general way followed to determine value (of a business, business ownership interest, security, or intangible asset) using one or more specific valuation methods (See also Asset Based Approach, Leveraged Valuation Approach, Market Approach and Income Approach).

Valuation MethodA specific process used to determine value (of a business, business ownership interest, security, or intangible asset).



Valuation MultipleA value, typically expressed as a factor, used to arrive at the business value; as a fraction, the value or price serves as the numerator and the financial, operating or physical data of the company being valued serve as the denominator.

Valuethe amount that is considered to be a fair equivalent for a business enterprise as agreed upon between a willing seller and a willing buyer; It is assumed that both buyer and seller are rational, and have a reasonable knowledge of relevant facts.

Vertical IntegrationA strategy in purchasing, sales, and distribution to achieve economies of scale. When a company acquires its supplier, it is called Vertical backward integration; whereas the acquisition of its output distribution chain is called Vertical forward integration.



WarrantiesA factual statement or opinion about the financial state of a company.

Working CapitalCurrent assets minus current liabilities.



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business valuation - glossary of terms

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