When it comes to business valuations, not all valuation reports are created equal.
In fact, the professional standards for both the American Institute of Certified Public Accountants and National Association Of Certified Valuation Analysts specify two distinct types of valuation engagements: a calculation engagement and a valuation engagement.
While the reports produced by both engagements share many common characteristics, it is important for business owners to understand the key differences and appropriate uses with each engagement.
Valuation Engagements
In a valuation engagement, the valuation analyst performs a full business valuation and produces a formal business valuation report. The report is extensive and contains a wealth of information related to the company’s background, industry, management, and past and projected future financial performance.
In addition, the analyst considers all three of the main valuation approaches (asset, income and market) and develops a conclusion of value, which can be expressed as a single value or a range of values. A valuation engagement requires the analyst to perform a detailed analysis of the company, which often includes a site visit and interviews with management.
Due to the level of work involved, valuation engagements typically have a higher cost than calculation engagements.
Calculation Engagements
In a calculation engagement, the analyst and the business owner agree on the valuation procedures to be performed for the report. The report is much more limited in scope than the report produced in a valuation engagement, and as a result is often less costly than a full valuation report.
Since the report does not include all the necessary requirements of a valuation engagement, the outcome is a calculated value rather than a conclusion of value. Calculation of value reports also tend to be more concise than full valuation reports since there is far less detail included and the analyst does not need to consider all the valuation approaches.
READ MORE: Business Valuation Methods: Pros & Cons for Business Owners
Which Report Do I Need?
The reason for the business valuation is the main factor in determining which type of report is most appropriate. The key difference between the reports is in the definition of the valuation outcome: conclusion versus calculated.
In situations where the valuation will be used in court (such as a divorce case) or will be submitted to the IRS (for a gift or estate tax filing, for example), a full valuation engagement is typically required. Because a formal valuation engagement was not performed, the courts and IRS usually do not accept a calculation report.
However calculation reports can be a perfectly viable option in a number of other less formal circumstances, such as the evaluation of an offer to purchase or sell a company, the determination of value for purposes of an owner exit or requirement of a buy-sell agreement, or as the starting point of a negotiation.
READ MORE: Business Valuation: When Businesses Need One and Why to Use a CVA (Video)
Conclusion
Before starting the valuation process, it is important to be clear about the purpose for the valuation and the uses of the report. For many business owners, a calculation engagement is a cost-effective solution for their valuation needs.
But if the valuation report is expected to be used by other parties or in a legal or tax setting, then a full valuation engagement needs to be seriously considered. In situations when the eventual use of the report may not be clear right away (such as a divorce case), a business owner might start with a calculation report as a preliminary negotiation tool and then upgrade if necessary to a full valuation report if the circumstances warrant.
A qualified valuation analyst can help review your specific valuation needs and offer guidance on the best engagement for your needs and budget. Click here to learn more about our valuation services and team.
