Common Terms & Descriptions

  • Adjustments to the Financial Statements: A valuation reviews the benefits stream (income measure such as EBITDA) where owner discretionary spending is adjusted or added back to earnings to normalize financial statements. Adjustments may include one-time charges and shareholder distributions beyond normal salary. Non-operating assets are also separated from operating assets.

  • Build-Up Method (BUM): Measures a company’s total business risk by starting with a risk-free rate (20-Year Treasury Bills) and adding an equity risk premium, company-specific risk premium, and size risk premium to reflect the subject company’s higher risk.

  • Capitalization Method: Converts a company's benefit stream into a present value using the formula: Benefit Stream / Capitalization Rate. It can be based on Cash Flow to Equity or Cash Flow to Invested Capital.

  • Capitalization Rate: The rate used to convert a company’s single-period income stream into a capitalized business value, calculated as the Discount Rate minus the Growth Rate.

  • Discounted Cash Flow Method (DCF): Determines a company’s present value by discounting future cash flows and termination value using an appropriate discount rate.

  • Discount Rate: The risk-adjusted rate used to convert future income streams into present value, often based on the weighted average cost of capital (WACC).

  • Excess Working Capital: The amount of working capital delivered at closing, adjusted for industry norms and liquidity needs. If working capital is insufficient, it reduces the purchase price.

  • Guideline Public Companies Method: Uses selling multiples from public companies to estimate private company value, usually applying a 30% discount for size and liquidity differences.

  • Net Cash Flow to Invested Capital: Measures cash flow available to both debt holders and shareholders, starting with EBITDA, adjusting for taxes and capital expenditures. Used in DCF and Capitalization of Earnings methods.

  • Weighting the Methods of Value: Valuation professionals may apply a weighted average of different valuation methods to best estimate a company’s Fair Market Value.

  • Weighted Average Cost of Capital (WACC): The company’s cost of financing (debt and equity), representing the minimum return required by investors. If return on invested capital (ROIC) exceeds WACC, value is created.

  • Market Value of Equity (MVE): Represents the business’s equity value after deducting interest and principal from net cash flow.

  • Market Value of Invested Capital (MVIC): Represents the total business value, including both debt and equity, without deducting interest or principal.

  • Scope of Appraisal: Defines the comprehensiveness of a valuation, ranging from limited (e.g., calculated value) to comprehensive appraisals.

  • Standard of Value: Refers to different valuation perspectives, including Fair Market Value, Fair Value, Investment Value, and Intrinsic Value.

  • Goodwill (Intangible Assets): The excess value of a business beyond tangible and identifiable intangible assets, often arising from acquisitions.

  • Earnings Before Interest & Taxes (EBIT): Represents a company's operating income before interest and taxes, separating operating and non-operating expenses.

  • Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA): EBIT plus depreciation and amortization, commonly used to assess a company's operating efficiency.

  • Net Operating Profit After Taxes (NOPAT): Operating income after taxes, providing a conservative measure of profitability by including tax liabilities, depreciation, and amortization.

  • Seller’s Discretionary Earnings (SDE): The profit available after all expenses, plus owner wages and non-cash expenses like depreciation and amortization, often used for small business valuations.

  • Fixed, Tangible, and Intangible Assets: Tangible assets (e.g. equipment) depreciate over time, while intangible assets (e.g. goodwill, patents) contribute value but are not physically observable.

  • Term Debt: Interest-bearing debt with repayment terms longer than one year, commonly used for financing equipment or transactions.

  • Working Capital: The difference between current assets and liabilities, essential for financing sales and maintaining liquidity.

  • Ratio Analysis: Evaluates profitability, liquidity, activity, and financial performance using data from the income statement and balance sheet.