Glossary

Part I
International Glossary of Business Valuation Terms

To enhance and sustain the quality of business valuations for the benefit of the profession and its clientele, the below identified societies and organisations have adopted the definitions for the terms included in this glossary.

The performance of business valuation services requires a high degree of skill and imposes upon the valuation professional a duty to communicate the valuation process and conclusion, in a manner that is clear and not misleading. This duty is advanced through the use of terms whose meanings are clearly established and consistently applied throughout the profession.

If, in the opinion of the business valuation professional, one or more of these terms needs to be used in a manner that materially departs from the enclosed definitions, it is recommended that the term be defined as used within that valuation engagement.

This glossary has been developed to provide guidance to business valuation practitioners by further memorialising the body of knowledge that constitutes the competent and careful determination of value and, more particularly, the communication of how that value was determined.

Departure from this glossary is not intended to provide a basis for civil liability and should not be presumed to create evidence that any duty has been breached.

American Institute of Certified Public Accountants

American Society of Appraisers

Canadian Institute of Chartered Business Valuators

National Association of Certified Valuation Analysts

The Institute of Business Appraisers

Accrual Basis Accounting- A method of accounting wherein income and expenses are recognised, within the statements, when the business first acquires the right to receive the income, or the obligation to pay the expense. Regular corporations are required to use the accrual basis by IRS. (Also see Cash Basis Accounting.)

Adjusted Book Value Method- A method within the asset approach whereby all assets and liabilities (including off-balance sheet, intangible, and contingent) are adjusted to their fair market values (NOTE: In Canada on a going concern basis).

Adjusted Net Asset Method- see Adjusted Book Value Method.

Aging Accounts Receivable- An analysis of the accounts receivable, usually alphabetised, as of the date of the balance sheet you are using, wherein each account receivable is shown in columnar form as either current, over 30 days, over 60 days, over 90 days, or over 120 days delinquent. Normally comments should be made regarding the accounts recent payment pattern and other indications regarding the probability of collection.

Amortisation- see Depreciation.

Appraisal- see Valuation

Appraisal Approach- see Valuation Approach.

Appraisal Date- see Valuation Date.

Appraisal Method- see Valuation Method.

Appraisal Procedure- see Valuation Procedure

Arbitrage Pricing Theory- A multivariate model for estimating the cost of equity capital, which incorporates several systematic risk factors.

Asset (Asset-Based) Approach- 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.

Balance Sheet- A statement of the financial status of the business on a certain date.

Beta- A measure of systematic risk of a stock; the tendency of a stock’s price to correlate with changes in a specific index.

Blockage Discount- An amount or percentage deducted from the current market price of a publicly traded stock to reflect the decrease in the per share value of a block of stock that is of a size that could not be sold in a reasonable period of time given normal trading volume.

Blue-Sky- That portion of a “claimed” value or requested price that cannot be supported, or generally shown to exist, through the application of established valuation methodology.

Book Value- see Net Book Value.

Business- see Business Enterprise.

Business Enterprise- A commercial, industrial, service, or investment entity (or a combination thereof) pursuing an economic activity.

Business Risk- The degree of uncertainty of realising expected future returns of the business resulting from factors other than financial leverage. See Financial Risk.

Business Valuation- The act or process of determining the value of a business enterprise or ownership interest therein.

Capital Asset Pricing Model (CAPM)- A model in which the cost of capital for any stock or portfolio of stocks equals a risk-free rate plus a risk premium that is proportionate to the systematic risk of the stock or portfolio.

Capitalisation- A conversion of a single period of economic benefits into value.

Capitalisation Factor- Any multiple or divisor used to convert anticipated economic benefits of a single period into value.

Capitalisation of Earnings Method- A method within the income approach whereby economic benefits for a representative single period are converted to value through division by a capitalisation rate.

Capitalisation Rate- Any divisor (usually expressed as a percentage) used to convert anticipated economic benefits of a single period into value.

Capital Structure- The composition of the invested capital of a business enterprise, the mix of debt and equity financing.

Cash Basis Accounting- A method of accounting wherein income and expenses are recognised, within the statements, when the business receives the income, or pays the expense. (Also see Accrual Basis Accounting.)

Cost Approach- A general way of determining a value indication of Cash Equivalents- Investment assets that can be quickly converted into cash.

Cash Flow- Cash that is generated over a period of time by an asset, group of assets, or business enterprise. It may be used in a general sense to encompass various levels of specifically defined cash flows. When the term is used, it should be supplemented by a qualifier (for example, "discretionary" or "operating) and a specific definition in the given valuation context.

Net Cash Flow- Net Cash Net income plus all non-cash charges (depreciation, amortisation and depletion), less amounts needed for capital expenditures, plus/minus net change in working capital, plus/minus changes in debt. (This would be net cash flow for equity, invested capital net cash flow would exclude the net change in debt and adjust net income to include interest expense, net of tax.)

Cash Flow Statement- A financial statement that displays the sources and uses of cash.

The Cash Flow Statement groups together funds in all activities whether they are in “Operations”, “Financing”, or “Investments”.

Common Size Statements- Financial statements in which each line is expressed as a percentage of the total. On the balance sheet, each line item is shown as a percentage of total assets, and on the income statement, each item is expressed as a percentage of sales.

Control- The power to direct the management and policies of a business enterprise.

Control Premium- An amount or a percentage by which the pro rata value of a controlling interest exceeds the pro rata value of a non-controlling interest in a business enterprise, to reflect the power of control.

Cost of Capital- The expected rate of return that the market requires in order to attract funds to a particular investment.

Cost of Goods Sold- A grouping of those expenses applicable to the materials and labour incorporated directly in the goods or services delivered.

Debt-Free- we discourage the use of this term. See Invested Capital.

Depreciation/Amortisation- In an economic sense, as used in recasting of statements, a loss in value of a fixed asset as a result of wear and tear or obsolescence, which cannot be corrected by normal repairs. In accountants’ financial statements, an expense item that permits the original cost to be written off against income over the assets’ cost recovery period, as dictated from time to time by the International Revenue Service. (In the context of the recasting of financial statements the amount of accumulated depreciation could be much greater or much less than the amount shown on the accountants’ statement.

Considered a non- cash charge (sometimes called a book charge) as this expense is allowed in excess of the interest expense, if the acquisition of the asset was financed.

How assets are paid for (all cash, financed, etc.) and how they are cost recovered (depreciated) are mutually exclusive!

Depending on the context used, it could be intended to mean- only depreciation, or more- broadly, to mean all non-cash charges (depreciation, amortisation, and depletion).

The amount of depreciation taken as a non-cash charge in any given accounting period is almost always based upon number of years approved by the IRS for cost recovery. IRS does not estimate the useful life of assets; may be recovered through a non-cash charge (depreciation) against the earnings of the business. Some analysts erroneously assume that if a business uses “straight line” depreciation, it is equal to economic depreciation because the business has not accelerated the depreciation. NOT TRUE! IRS freely admits that the estimated useful life of most assets is significantly greater than the number of years they approve for cost recovery. Therefore, nearly all depreciation charges, based upon IRS’ number of years of useful life, are accelerated. (See Appendix).

Discount for Lack of Control- An amount or percentage deducted from the pro rata share of value of 100% of an equity interest in a business to reflect the absence of some or all of the powers of control.

Discount for Lack of Marketability- An amount or percentage deducted from the value of an ownership interest to reflect the relative absence of marketability.

Discount for Lack of Voting Rights- An amount or percentage deducted from the per share value of a minority interest voting share to reflect the absence of voting rights.

Discount Rate- A rate of return used to convert a future monetary sum into present value.

Discounted Cash Flow Method- A method within the income approach whereby the present value of future expected net cash flows is calculated using a discount rate.

Discounted Future Earnings Method- A method within the income approach whereby the present value of future expected economic benefits is calculated using a discount rate.

Discretionary Earnings- Adjusted earnings before taxes, interest income or expense, non-operating and nonrecurring expenses, depreciation and other non- cash charges and prior to deducting an owner’s/officer’s compensation.

Earnings- The gross operating revenues of the business less the expenses and other deductions applicable to the type of earnings you are defining:

EBT Earnings before taxes. Earnings of the business prior to income Taxes paid.

EBDT Earnings before depreciation (and other non-cash charges) & taxes.

EBIT Earnings Before Interest and Taxes = Earnings of the business prior to Interest expense or income + corporate income Taxes paid. This definition recognises interest as a cost of capital, and not as an operating expense; or the recasting is being done on a debt-free basis.

EBDIT Earnings before depreciation (and other non-cash charges) interest, & taxes.

EBITDA Earnings Before Interest, Taxes, Depreciation, and Amortisation = Earnings of the business prior to Adjusted Net Income + Interest expense or income + corporate Taxes paid + all Depreciation and Amortisation Expenses.

EBITDA + OC Earnings Before Interest, Taxes, Depreciation, and Amortisation Plus Owners’ Compensation = Earnings off the business prior to Interest expense or income + corporate Taxes paid + Depreciation, and Amortisation + all Owners’ compensation and benefits.

SDCF Seller’s Discretionary Cash flow = Earnings of a business prior to: Income taxes + non-operating income and expenses, non-recurring income and expenses + depreciation and amortisation + interest expense or income, + owner’s total compensation for those services that could be provided by a sole owner/manager.

Economic Benefits- Inflows such as revenues, net income, net cash flows, etc.

Economic Life- The period of time over which property may generate economic benefits.

Effective Date- see Valuation Date.

Enterprise- see Business Enterprise.

Equity- The owner’s interest in property after deduction of all liabilities.

Equity Net Cash Flows- Those cash flows available to pay out to equity holders (in the form of dividends) after funding operations of the business enterprise, making necessary capital investments, and increasing or decreasing debt financing.

Equity Risk Premium- A rate of return added to a risk-free rate to reflect the additional risk of equity instruments over risk free instruments (a component of the cost of equity capital or equity discount rate).

Excess Earnings- That amount of anticipated economic benefits that exceeds an appropriate rate of return on the value of a selected asset base (often net tangible assets) used to generate those anticipated economic benefits.

Excess Earnings Method- A specific way of determining a value indication of a business, business ownership interest, or security determined as the sum of a) the value of the assets derived by capitalising excess earnings and b) the value of the selected asset base. Also frequently used to value intangible assets. See Excess Earnings.

Fair Market Value- The price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arms length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts

Fairness Opinion- An opinion as to whether or not the consideration in a transaction is fair from a financial point of view.

FIFO- First In First Out. An accounting method of valuing inventory, based on the assumption that the “first” unit of an item of inventory purchased (the oldest) is the first unit sold out of inventory.

In pricing the inventory under this valuation method the ending inventory is the aggregate of the cost of the newest, most recently purchased units of each item.

The end result of this inventory valuation method is that the ending inventory value is higher and, therefore the cost of goods sold is lower, which in turn makes the gross profit – and the net profit greater. (See also LIFO).

Financial Risk- The degree of uncertainty of realising expected future returns of the business resulting from financial leverage. See Business Risk.

Forced Liquidation Value- Liquidation value, at which the asset or assets are sold as quickly as possible, such as at an auction.

Free Cash Flow- we discourage the use of this term. See Net Cash Flow.

Going Concern- An ongoing operating business enterprise.

Going Concern Value- The value of a business enterprise that is expected to continue to operate into the future. The intangible elements of Going Concern Value result from factors such as having a trained work force, an operational plant, and the necessary licenses, systems, and procedures in place.

Goodwill- A term with much disagreement, even whether it should be spelled as one word or two. As used by your instructor it will mean:

That intangible asset that arises as a result of name, reputation, customer patronage, location, products and similar factors that have not been separately identified and/or valued but which generate economic benefits.

For some, goodwill is synonymous with Blue-Sky. This view results from a lack of understanding of the difference. (Also see Blue-Sky).

Goodwill Value- The value attributable to goodwill.

Guideline Public Company Method- A method within the market approach whereby market multiples are derived from market prices of stocks of companies that are engaged in the same or similar lines of business, and that are actively traded on a free and open market.

Gross Profit- That portion of net sales that remains after the subtraction of the Cost of Goods Sold.

Income- See Earnings.

Income (Income-Based) Approach- A general way of determining a value indication of a business, business ownership interest, security, or intangible asset using one or more methods that convert anticipated economic benefits into a present single amount.

Income Statement- A financial statement used to summarise the financial activities of a business during the period of time specified within the statement. A.K.A, Income/Expense Statement, Profit & Loss, P & L.

The Income Statement and Balance Sheet are normally issued together, as companion documents, each supplementing the other.

Intangible Assets- Non-physical assets such as franchises, trademarks, patents, copyrights, goodwill, equities, mineral rights, securities and contracts (as distinguished from physical assets) that grant rights and privileges, and have value for the owner.

Internal Rate of Return- A discount rate at which the present value of the future cash flows of the investment equals the cost of the investment.

Intrinsic Value- The value that an investor considers, on the basis of an evaluation or available facts, to be the “true” or “real” value that will become the market value when other investors reach the same conclusion. When the term applies to options, it is the difference between the exercise price or strike price of an option and the market value of the underlying security.

Invested Capital- The sum of equity and debt in a business enterprise. Debt is typically a) all interest bearing debt or b) long-term interest-bearing debt. When the term it used, it should be supplemented by a specific definition in the given valuation context.

Invested Capital Net Cash Flows- Those cash flows available to pay out to equity holders (in the form of dividends) and debt investors (in the form of principal and interest) after funding operations of the business enterprise and making necessary capital investments.

Investment Risk- The degree of uncertainty as to the realisation of expected returns.

Investment Value- The value to a particular investor based on individual investment requirements and expectations.

Key Person Discount- An amount or percentage deducted from the value of an ownership interest to reflect the reduction in value resulting from the actual or potential loss of a key person in a business enterprise.

Levered Beta- The beta reflecting a capital structure that includes debt.

LIFO- Last In First Out. An accounting method of valuing inventory, based on the assumption that the “last”, most recent, unit of an item of inventory purchased is the first unit sold out of inventory.

In pricing the inventory under this valuation method the ending inventory is the aggregate of the cost of the oldest units of each item, purchased within the accounting period.

The end result of this inventory valuation method is that the ending inventory value is lower and, therefore, the cost of goods sold is higher, which in turn makes the gross profit- and the net profit lower. (Aso see FIFO).

Limited Appraisal- The act or process of determining the value of a business, business ownership interest, security, or intangible asset with limitations in analyses, procedures, or scope.

Liquidity- The ability to quickly convert property to cash or pay a liability.

Liquidation Value- The net amount that would be realised if the business is terminated and the assets are sold piecemeal. Liquidation can be either “orderly” or “forced”.

Majority Control- The degree of control provided by a majority position.

Majority Interest- An ownership interest greater than 50% of the voting interest in a business enterprise.

Market (Market-Based) Approach- 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, securities, or intangible assets that have been sold.

Market Capitalisation of Equity- The share price of a publicly traded stock multiplied by the number of shares outstanding.

Market Capitalisation of Invested Capital- The market capitalisation of equity plus the market value of the debt component of invested capital.

Market Multiple- The market value of a company’s stock or invested capital divided by a company measure (such as economic benefits, number of customers).

Marketability- The ability to quickly convert property to cash at minimal cost.

Marketability Discount- see Discount for Lack Marketability.

Merger and Acquisition Method- A method within the market approach whereby pricing multiples are derived from transactions of significant interest in companies engaged in the same or similar lines of business.

Mid-Year Discounting- A convention used in the Discounted Future Earnings Method that reflects economic benefits being generated at midyear, approximating the effect of economic benefits being generated evenly throughout the year.

Minority Discount- A discount for lack of control applicable to a minority interest.

Minority Interest- An ownership interest less than 50% of the voting interest in a business enterprise.

Multiple- The inverse of the capitalisation rate.

Net Book Value- With respect to a business enterprise, the difference between total assets (net of accumulated depreciation, depletion, and amortisation) and total liabilities as they appear on the balance sheet (synonymous with Shareholder’s Equity). With respect to a specific asset, the capitalised cost less accumulated amortisation or depreciation as it appears on the books of account of the business enterprise.

Net Cash Flows- when the term is used, a qualifier should supplement it. See Equity Net Cash Flows and Invested Capital Net Cash Flow.

Net Present Value- The value, as of a specified date, of future cash inflows less all cash outflows (including the cost of investment) calculated using an appropriate discount rate.

Net Profit- Total revenues less all deductible items. Should identify as pre-tax or post-tax.

Net Tangible Asset Value- The value of the business enterprise’s tangible assets (excluding excess and non-operating assets) minus the value of its liabilities.

Net Worth- Total assets minus total liabilities, as reflected by the balance sheet. Synonymous with net book value or owner’s equity.

Non-Operating Assets- Assets not necessary to ongoing operations of the business enterprise.

Normalised Earnings- Economic benefits adjusted for nonrecurring, non-economic, or other unusual items to eliminate anomalies and/or facilitate comparisons.

Normalised Financial Statements- Financial statements adjusted for non-operating assets and liabilities and/or for nonrecurring, non-economic, or other unusual items to eliminate anomalies and/or facilitate comparisons.

Orderly Liquidation Value- Liquidation value at which the asset or assets are sold over a reasonable period of time to maximise proceeds received.

Ownership- A generic term used within this book to mean 100% controlling ownership; whether or not incorporated, and without the distinction that the owner of an unincorporated business owns the business’ assets, while the owner of a corporation owns the stock of the corporation – that owns the assets. (This is an important distinction, but not for the purposes of this primer course.)

Perquisites- Special additional benefits received because of position. In closely held businesses these are often a result of the business’ ability to pay for them, more than a result of market rate compensation for the services provided to the business. (Abbreviation – perks), e.g. company paid vehicles, insurance, travel, memberships, salary in excess of market rate, bonuses, etc.

Premise of Value- An assumption regarding the most likely set of transactional circumstances that may be applicable to the subject valuation; e.g. going concern, liquidation.

Present Value- The value, as of a specified date, of future economic benefits and/or proceeds from sale, calculated using an appropriate discount rate.

Portfolio Discount- An amount or percentage deducted from the value of a business enterprise to reflect the fact that it owns dissimilar operations or assets that do not fit well together.

Price/Earnings Multiple- The price of a share of stock divided by its earnings per share.

Rate of Return- An amount of income (loss) and/or change in value realised or anticipated on an investment, expressed as a percentage of that investment.

Redundant Assets- See Non-Operating Assets.

Report Date- The date conclusions are transmitted to the client.

Replacement Cost New- The current cost of a similar new property having the nearest equivalent utility to the property being valued.

Reproduction Cost New- The current cost of an identical new property.

Required Rate of Return- The minimum rate of return acceptable by investors before they will commit money to an investment at a given level of risk.

Reserve For Replacement- A financial provision for recognising the reduction in value of assets over their estimated useful life. This is done by making regular additions to a fund sufficient to meet the estimated cost of additions to and replacements of the fixed assets when they come to the end of their useful life. The useful life could end due to wearing out, or becoming obsolete due to changes in the state of the art. (This reserve is seldom “actually” money set aside for when needed.) In concept the reserve for replacement is similar to the charge for depreciation, except when used it is often based on the estimated economic (actual) lessening in value rather than the cost recovery period approved for write-off against taxable income.

Residual Value- The value as of the end of the discrete projection period in a discounted future earnings model.

Return on Equity- The amount, expressed as a percentage, earned on a company’s common equity for a given period.

Return on Investment- See Return on Invested Capital and Return on Equity.

Return on Invested Capital- The amount, expressed as a percentage, earned on a company’s total capital for a given period.

Risk-Free Rate- The rate of return available in the market on an investment free of default risk.

Risk Premium- A rate of return added to a risk-free rate to reflect risk.

Rule of Thumb- A mathematical formula developed from the relationship between price and certain variables based on experience, observation, hearsay, or a combination of these; usually industry specific.

Special Interest Purchasers- Acquirers who believe they can enjoy post-acquisition economies of scale, synergies, or strategic advantages by combining the acquired business interest with their own.

Standard of Value- The identification of the type of value being used in a specific engagement; e.g. fair market value, fair value, investment value.

Sustaining Capital Reinvestment- The periodic capital outlay required to maintain operations at existing levels, net of the tax shield available from such outlays.

Systematic Risk- The risk that is common to all risky securities and cannot be eliminated through diversification. The measure of systematic risk in stocks is the beta coefficient.

Tangible Assets- Physical assets (such as cash, accounts receivable, inventory, property, plant and equipment, etc.).

Terminal Value- See Residual Value.

Transaction Method- See Merger and Acquisition Method.

Unlevered Beta- The beta reflecting a capital structure without debt.

Unsystematic Risk- The risk specific to an individual security that can be avoided through diversification.

Valuation- The act or process of determining the value of a business, business ownership interest, security, or intangible asset.

Valuation Approach- A general way of determining a value indication of a business, business ownership interest, security, or intangible asset using one or more valuation methods.

Valuation Date- The specific point in time as of which the valuator’s opinion of value applies (also referred to as “Effective Date”).

Valuation Method - Within approaches, a specific way to determine value.

Valuation Procedure- The act, manner, and technique of performing the steps of an appraisal method.

Valuation Ratio- A fraction in which a value or price serves as the numerator and financial, operating, or physical data serves as the denominator.

Value to the Owner - See Investment Value.

Voting Control- de jure control of a business enterprise.

Weighted Average Cost of Capital (WACC)- The cost of capital (discount rate) determined by the weighted average, at market value, of the cost of all financing sources in the business enterprise’s capital structure.

Working Capital- The excess of the value of the current assets over the value of the current liabilities.

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