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How to Tie a Balance Sheet to a Business Valuation

Original post by Lisa Bigelow of Demand Media

Business valuations often "normalize" for unusual past activity.

The balance sheet is the financial history of a business's assets and liabilities as of a certain date. It's one of many statements that analysts use to determine a business's value, which can be calculated in a variety of ways. The most common approach combines a prediction of what a business will earn in the future based on its past earnings, and as a result, a potential purchaser's return on investment, with an analysis of its assets and market value. Because business valuation is subjective -- and business conditions occasionally unpredictable -- even the most sure-footed valuation may be wrong.

Contents

Step 1

Analyze the business's cash flow and past earnings to predict future return on investment. A business with a long history of solid, predictable earnings with little competition is worth more than a new, unproven business, unless the new business has an explosive new product, a patented invention or other idea that revolutionizes the industry. Valuations often eliminate unusual revenue and expense activity to provide a "normalized" view of operations.

Step 2

Review the business's balance sheet assets and liabilities. Some valuations add all of the business's assets together and call that a valuation; other valuations subtract the value of the liabilities from the assets. Another approach predicts what a business would be worth if it had to be liquidated. Concerning liabilities, a company with solid earnings that is struggling with debt that it can't refinance -- or bills that it can't pay -- may be low-hanging fruit for a cash-rich buyer.

Step 3

Compare the business to different, similarly sized businesses that have recently sold. This market-based approach allows the valuation to make assumptions about the difficulty of selling into a rising -- or falling -- market environment.

Step 4

Decide on a value based on the balance sheet assets and liabilities, cash flow, income and market value. Corporate financiers each have their own ways and means of valuing a business; hence, it's largely subjective, and intangibles can play a big role. A simple back-of-the-envelope subtraction of assets less liabilities, while easy, rarely encompasses all that a business has to offer. As a result, the careful analysis of all financial statements and the market it inhabits is the best approach to a true valuation.


                   

Things Needed

  • Balance sheet
  • Income statements, at least two years
  • Cash flow statements, at least two years

References

About the Author

Lisa Bigelow is a freelance writer and editor. She is a former financial analyst and worked at a college, a media company and an investment bank. She also contributes to Patch. Lisa graduated from the State University of New York, Plattsburgh with a Bachelor of Arts in mathematics.

Photo Credits

  • Jupiterimages/Comstock/Getty Images


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