The value of large, publicly traded companies, such as those listed on the New York Stock Exchange or NASDAQ, are calculated thousands of times a day through active trading of buyers and sellers in the stock market. In general, this price is recognized as fair market value. For privately-owned companies, nevertheless, the stock does not have a competitive demand, so valuation becomes even more complex. For donation or inheritance tax purposes or to partake in the selling of your business, an assessment of the worth of your business should be undertaken.
Furthermore, owners tend to use internal financials versus their tax returns when selling and valuing a business. But remember, in a business appraisal, tax returns count most. There are many explanations for this, so we broke them down into the most significant ones below:
- Tax returns are often on the cash basis for smaller businesses because, on the accrual basis, cash basis earnings are typically lower than those.
- To minimize taxes, tax returns are primed. Who wants to pay taxes that are higher, right? Paying taxes on solid earnings, however, is an “investment” when a business is sold.
- On the smaller line items on the tax returns, the owner’s benefits can be buried relative to the unrestricted accounts in the internal financials.
- Typically, internal financials are ready within 15-30 days after month-end, while tax returns can be several months behind the taxable year-end.
- Tax returns can be old data, while the latest is a snapshot of internal financials. Moreover, the most recent tax returns are difficult for owners to use as a measuring stick of recent changes to the business.
- Depreciation, amortization, and interest payments often aren’t adjusted every month for the internal financials.
- Uncollectable accounts are not written down or off, which can skew numbers and percentages.
An important aspect of whether tax returns or internal financials are used is they MUST tie together. For instance, a seller or company owner may want to use the cash basis on the Tax Returns and Accrual on internals as big moves in payments, and inventory/job costing purchases skews the profit numbers one way or the other. Also, it is prudent for smaller businesses not to realize income until all monies are collected (cash versus accrual basis).
Your CPA should, however, be able to provide journal entries for both the start and end of the year that link the tax returns and internal financials together. It is important that inventory (if applicable), work costs (if applicable), and receivable accounts are transparent, concise, and relevant as the “bodies are hidden” in inventory and receivable accounts of the business and their consistency, saleability, and collectability must be handled.
Transactions are often usually financed by banks or other kinds of lenders. Also, tax returns bear a greater degree of authenticity than internal figures. Many closings have been delayed up or canceled by the absence of tax returns and YTD financials less than 45 days old.
For another purpose, you may have had your business assessed in the past. Don’t use an outdated appraisal now, as enticing as it may be. The purpose of the evaluation will influence the given value, and time will alter the considerations that go into the assessment of the appraisal.