Tagged: AICPA

Accounting Practice Sales

You may wonder why I have called my website Perpetual Prose… well.  Because, I am one of those geeks who sees ‘number crunching’ as a form of prose!  I love working with numbers and I always have and I always will.   I feel the same way about a good spreadsheet as an academic does a book by Charles Dickens or Maupassant.

I would love to write my own book on accountancy too – to bring together my two greatest loves.  In face, there has never been an easier time for writers to self publish their own work, and a number of individuals have been successful with the direct publishing route.  Yet the self publishing route has almost as many advantages as disadvantages.  Despite the challenges faced in what can only be described as a mature market,  one professional services sector is seeing a dramatic increase in published work.  The subject of accounting may bring back tremors of fear for the typical writer, yet the accounting sector is seeing a dramatic increase in successful self published text books, challenging the status quo held by the large and established professional educational publishing firms.

Technical authors are a unique breed that need to understand the often complex issues that are discussing as well as present the information in a way that their readership (typically accounting students) remain engaged.  Mixed in with this is the need to integrate working numerical accounting examples into the text, a task which needs careful editing and placement.  In the article below we take a look at an accounting article focusing on business valuations, an area both professional accountants, and business owners need to be aware of.  This is an important issue that accountancy practices themselves need to be aware of, particularly as many accounting practices are valued on the basis of multiples of gross revenue.  More details on accounting practice sales including valuations can be found at the Accounting Practice Exchange.

Accountants are often asked by existing and potential clients to undertake business valuations on their behalf.  Often this is because the existing business owner is thinking of retiring or selling out and moving on to new and fresh challenges.  Yet the subject of valuations is a complex one, particularly from an accounting perspective, primarily due to the fact that there are a number of ways accountants can value a business.  Below you will find a summary provided by the Accounting Practice Exchange, a site dedicated to assisting CPA’s with the Accounting practice sales process.  This will certainly make interesting reading to American CPA’s who are either approaching retirement or are thinking of selling or merging their accounting practice.

Typically accountants value a business for one of three reasons.  Firstly, as a means to raise money by selling a business, secondly, as a method of raising finance by floating a business, and finally as part of the process of acquiring or buying a business.  A variety of issues can effect the valuation that an accountant can arrive at.  Naturally there are any number of reasons for a sale, but key issues include the current liquidity of the company, it’s debt structure and it’s ability to repay those debts when they fall due, the current and expected trading results, as well as other factors effecting the general marketplace that the business operates within.

No two businesses are the same, and a consequence of this is that accountancy firms are faced with other issues such as how to value intangible assets and how to treat goodwill that may arise from the sale.  There are typically three different approach’s that accountants use when valuation a business.  These are: (1) Asset Basis, (2) Earnings Basis and (3) Dividend Valuation Model.  Below we briefly discuss all three  methods.

Often used by accountancy firms as a ‘rule of thumb’ method of valuation, the asset based approach is technically the most straightforward approach and consequently the easiest to understand.  This method draws upon the basic principles of accounting, that assets less liabilities must equal the capital invested in the business.  In nearly all educational accountancy text books, the ‘accounting equation’ as it is known forms the first lesson that accountancy students are taught.  There are three slightly different methods used by accountants when implementing an asset based valuation and the method used will depend on the particular situation that the selling business finds itself in.  A straight balance sheet valuation is the accountants stock favourite method that can easily be achieved by looking at the balance sheet and simply calculating the net assets of the business (assets less liabilities).  A replacement cost basis is a slightly different approach whereby accountants look at the assets that the business possesses and then calculate their replacement cost (usually with the help of third party valuation specialists).  The final asset based approach favoured by accountancy firms looks at the realisable value (or break up value) of the assets.  This approach is typically used as a last resort and is normally only used in cases of pending insolvency or fire sales.

The second approach used by accountancy practices in valuing businesses is the earnings based approach.  This is a popular method and is based on a companies price earnings ratio, often described as P/E ratio in the financial press.  The basic accounting formula that underlines this approach is that the P/E ratio of a business is equal to the market price per share, divided by the earnings per share.  In cases where the earnings per share is not provided or published, accountants typically calculate this figure by dividing the profit after tax and preference dividends by the total number of ordinary equity shares that are issued within the business.  Naturally, the earnings based approach is best used in circumstances where the business is publicly owned and it’s shares issued and traded on a public exchange.  However, this method can and is used by accountants in valuing unquoted companies.  When valuing an unquoted company, the accountant would usually attempt to find the P/E ratio of a similar quoted business and then adjust it down on the basis that there is a lower marketability of non-listed company shares.

Accounting Practice Exchange - specialists in accounting practice salesThe final approach used by accountants and professional service firms in arriving at valuations is the dividends approach.  With this method accountants value a business on the future dividends that the business is expected to generate.  This approach is built upon the accounting fact that the value of a share in a business s equal to the present value of future cash flows earned from holding that share.  Naturally these method requires some considerable judgement or in many cases estimates as to what a businesses future dividends are likely to be.  These figures are then discounted to arrive at net present value from which a business valuation can be derived.