When it comes to business valuation, people often use the terms appraisal, valuation, and evaluation interchangeably. This leads to the question: what is the difference between the three terms? The internet offers many viewpoints on the distinctions between them. A quick Google search for evaluation vs. valuation, appraisal vs. valuation, or any combination of the three terms will turn up a slew of articles written to point out the differences they have depending on the industry.
But despite the available resources, the terms are still often interchange. To address this confusion, let’s define the terms based on the point of view of business valuation companies and appraisers. Why? Because they seem to have different perspectives on the concepts and how they vary. We’ll compare these terms and their descriptions, as well as the data gathered. We’ll also include the steps taken to get to the final result of an appraisal, valuation, or evaluation.
Differentiating Valuation and Evaluation
Most business valuation companies consider appraisal (more often used in valuing real estate) or valuation to be terms that describe assigning a monetary value to a tangible or intangible asset. However, there is a significant difference between valuation and evaluation. A valuation is a structured analysis that encompasses all aspects of value with verified documentation. An evaluation, on the other hand, is a more informal type of assessment. Most people assume that there is little distinction between the two. Sometimes, they even believe that they are completely the same. To describe it lightly, financial reports, comparables, multiples, assets, etc., are factors that need to be evaluated first prior to the commencement of the business valuation process.
However, in reality, the terms appraisal, valuation, and evaluation are frequently used interchangeably when a business valuation is being discussed. In order to effectively gain an understanding of the distinctions, the sense in their usage is more relevant. Evaluation is part of a larger process—which is the business valuation itself.
When it comes to valuation, there are three approaches that can be used:
- Market Approach – The market approach is driven by competition. The evaluator will compare the selling rates of competing companies. Then, use the information to determine how much your company is worth. This procedure is somewhat similar to the one used in assessing the worth of a house.
- Income Approach – The income approach can be performed in a number of ways. It is, at its base, the projected economic value and level of risk associated with a business investment. The actual cash flow would be capitalized, discounted, or compounded, depending on the formula used, to help calculate the company’s potential financial worth.
- Asset Approach – This is best explained as the sum of all the measurable components that make up a business. The asset approach involves removing all of the equipment, stock, and materials and selling them separately to determine their valuation. For future investors or owners, this total figure becomes part of the company’s total valuation.
Differentiating Appraisal and Valuation
A company owner wants to know the real worth of his or her real estate investments for a multitude of reasons. A real estate appraisal and a business valuation are often both needed when applying for a business loan. For instance, the lender is a traditional bank. When splitting ownership, solving partnership disputes, or seeking to bring in a third party, a business valuation is often needed. You will also need a business valuation with a personal goodwill allocation, for tax purposes if you’re gifting a part of your company for estate planning purposes, just as you’d like to know the value of your home before selling it.
A company owner does not have to request a business appraisal. On the flip side, depending on the situation, a commercial lender, company owners, legal professionals, tax authorities, or even the courts can demand a business valuation. The method used to assess its worth would be affected by the valuation’s purpose as well as who it is for.
Differentiating Evaluation and Appraisal
A business appraisal’s main goal is to figure out a company’s financial value. It also analyzes all investments, especially when taking into account all involved risks and liabilities. An evaluation of a business assesses the intangible. Since it measures the operations of the business to see how effectively and consistently it generates cash flow. An owner or the management typically uses this type of business tool in an attempt to enhance cash flow or profits by improving productivity.
Take note that an accredited professional should be the one to do a certified business valuation in order for it to be legitimate. These valuation professionals are experts at analyzing statistics and developments in order to come to a rational conclusion about a company’s value. The certified appraiser’s reports should be both timely and precise. This allows you to go on with the deal that prompted the business appraisal in the first place.
Furthermore, regardless of the terms used—valuation vs. evaluation, appraisal vs. valuation, or evaluation vs. appraisal—determining the worth of a company or business properties is a difficult task. It necessitates the knowledge of certified professionals, typically denoted by the CVA designation. This is why business valuation experts offer their knowledge and experience to help company owners establish a fair and justifiable value for their respective businesses.