What is an Appraisal?
An appraisal is basically a way to conduct an unbiased analysis or evaluation of a business, organization, or performance against a given set of standards or criteria. Performed by a qualified appraiser, an appraisal is usually done whenever a property or asset is to be sold, and its value needs to be determined, or to establish the tax obligations of a particular business.
As for the appraiser, he or she should be designated by the governing body that oversees his practice. There are different valuation methods that can be used when appraising property, depending on what the appraiser deems most suitable and applicable.
Types of Business Appraisals
Below are some of the appraisal methods commonly used by businesses:
1. Business assets
Business assets are commonly appraised, especially in instances when the business must cease operations. In doing so, the appraiser is looking to determine the assets’ book value This is calculated by deducting the business’ liabilities from the assets.
2. Capitalization of earnings
A more popular method for appraising a business is by determining its earnings. In capitalization of earnings, documented earnings in the past are looked into and given weight. The appraiser gives the most weight to the most recent earnings, and progressively less and less weight to older earnings records.
3. Future earnings
In contrast to the previous type of appraisal that uses historical earnings, discounted future earnings look at the anticipated future earnings of a business. After the projected earnings are determined, a discount rate is used. Both the future earnings method and the capitalization of earnings give the greatest weight to present earnings and less to future earnings.
4. Capitalization factor
The capitalization factor method type of appraisal is determined by dividing the required rate of return by 100, which is usually 10, resulting in 10 as the capitalization factor.
Importance of Business Appraisal
Business valuation or appraisal is important to every organization. In fact, it is indispensable for many reasons, such as:
1. Buying and selling a business
Before a company is sold or bought or companies merge, an appraisal must be completed in order to come up with the most accurate value of the company or companies.
For example, if Business A is going to be bought by Business B, an appraisal will determine the most accurate price for the company. This helps ensure that Business B won’t need to pay an amount that is too high, nor Business A to receive anything less than its actual value or price.
2. Settling legal disputes
Legal disputes among businesses are also common, often caused by disagreements or a breach of contract. When such things happen, the people involved seek legal action, as it is the most effective way to settle disputes. The court that handles the case will require a business appraisal. This is done so that if the need to re-allocate funds, sell the business, or liquidate assets arises, the details are all ready.
3. Determining the value of intellectual property
While most people think the only aspect to be appraised in a business is its tangible assets, intangible assets can also be appraised, such as intellectual property. Determining the value of the intellectual property of a business is necessary because it is deemed to contribute to the overall value of the business.
4. Determining tax liability
Every business is subject to tax duties. Taxes are calculated according to the monetary value of the business; the bigger the estimated value of the business, the larger the tax due.
5. Raising funds
When a business wants to attract and convince investors to put their money into the company, the easiest way to do that is to present an appraisal value. If the value of the company is high, it can drive investors to invest more in the business.
Appraisals in Insurance Claims
Businesses and individuals often take out an insurance policy to protect their property from any accidents. However, claiming benefits from the policy can be rigorous and time-consuming; appraisals are a way to hasten the process. When an inventory of the contents of a house is ready and appraised, estimating their value becomes easier, and the claim is settled more quickly.
Thank you for reading CFI’s explanation of appraisal. CFI is the official provider of the Financial Modeling and Valuation Analyst (FMVA)™ certification program, designed to transform anyone into a world-class financial analyst.
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