Top 10 Business Valuation Terms for Business Owners and Attorneys (Part 1 of 2)
Whether we were counting down a top 10 list on The Late Show with David Letterman or are listening to the top 10 most requested songs on our favorite radio station, it seems like there is a way for everyone to enjoy a top 10 countdown. What makes these countdowns so exciting? I don’t know the exact answer, but I do know that after watching ESPN SportsCenter’s top 10 plays of the day over the years, the countdowns can certainly be thrilling.
While not quite as thrilling as a half-court buzzer beater, I have compiled a top 10 countdown of business valuation definitions to help business owners and attorneys gain a better understanding of key terms used in business valuations. Jargon has developed in the field of valuation that, while a second language to valuation experts, may sound foreign to those not familiar with the process.
To help clear up any confusion, I’ll begin part one of this top 10 countdown by defining the following terms noted below. Let the countdown begin! Drum roll please…
10) Enterprise Value – Represents the total value of the company, regardless of how it is financed. A company’s enterprise value is often determined through the application of EBITDA or revenue multiples. Enterprise value is equal to the fair market value of equity plus debt less the cash balance as of the valuation date (the same formula can also be used to convert an enterprise value to an equity value).
9) Required Rate of Return – This is the theoretical rate of return that an investor will require to make an investment in a company, taking into consideration the level of risk associated with the investment. The higher the level of risk perceived by the investor, the higher the required rate of return an investor will demand, and the lower the value of the investment will be.
8) Normalizing Adjustments – These are adjustments made to a company’s historical financial statements to eliminate any non-recurring, non-operating or discretionary business expense items in order to give a valuation analyst a foundation for developing expectations about the company’s future performance and cash flows. In other words, these adjustments take the company’s historical reported earnings or cash flows to a “normal,” sustainable level of earnings or cash flows.
7) Net Working Capital – In the business valuation world, net working capital is typically calculated as non-cash current assets less non-debt current liabilities. The greater the level of required net working capital, the more income that must be reinvested in the company to fund future growth.
6) EBITDA (earnings before interest, taxes, depreciation, and amortization) – A rough estimate of the annual cash flow available to a company’s owners and debt holders. Therefore, valuation multiples based on EBITDA are very common.
Stay tuned for part two, coming soon!