Using Lower Level Business Valuations Effectively
Under the Statement of Standards for Valuation Services (SSVS) published by the American Institute of Certified Public Accountants (AICPA) there are two types of valuation engagements – calculation and valuation. Certified Public Accountants (CPA’s) who are members of the American Institute of Certified Public Accountants and are engaged to estimate the value of a business are required to follow the Statement of Standards for Valuation Services.
A calculation engagement is when the business valuation professional and the client agree on the valuation approaches, methods and procedures BEFORE beginning the engagement. The business valuation professional performs the agreed upon procedures and reports the results as calculated values. A calculation engagement does not include all of the procedures required for a valuation engagement. The calculation engagement report should include a disclaimer that had a valuation engagement been performed, the results might have been different.
A valuation engagement is where the valuation professional is free to apply the valuation approaches, methods and procedures deemed most appropriate by the BVP. The results of a valuation engagement are expressed as a conclusion of value.
The differences between these two types of engagements are not widely understood and often misapplied even by business valuation professionals. Sub-standard and limited scope valuations are sometimes incorrectly labeled as calculation engagements. If the engagement letter does not specify the approaches, methods and procedures to be used then it is NOT a calculation engagement.
A calculation engagement consists of predetermined procedures being performed and presented by a business valuation professional – no more, no less. Sometimes that may be enough. Calculation engagements often work well for very small, owner-operated businesses because the size of the business, poor record-keeping, and budget constraints make a full-blown valuation engagement impractical.
Valuation engagements can be very expensive. Many small businesses simply can’t justify the cost and use other methods to determine business value, like industry rule of thumb formulas. Using these methods solves the cost issue, but rarely provides a credible estimate of business value.
The advantages of a calculation engagement are that it can be: 1) Less expensive than a valuation engagement; 2) Tailored to fit the facts and circumstances of the case; 3) Performed more quickly than a valuation engagement; 4) Easier to explain; and 5) Focused more on the procedures than professional judgment.
The disadvantages of a calculation engagement are that: 1) Relevant procedures may not have been considered; 2) The impact of omitted procedures are unknown; and 3) Calculated values are not fair market or fair value.
To maximize the effectiveness of a calculation engagement, considerable effort should be given to selecting the most appropriate approaches, methods and procedures when defining the engagement. The selected procedures should be included in a signed engagement letter to show that they were agreed upon prior to the engagement.
In some cases, a properly designed and performed calculation engagement may be an effective, low-cost alternative to estimate the value of a business instead of getting a full-blown valuation, and is much better than not getting one at all.