Glossary Of Terms

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Adjusted Book Value.  The Book Value (equity) of a company after adjusting the values of assets and liabilities to reflect estimated market values rather than depreciated tax values and removing non-operating assets and liabilities from the balance sheet.

Adjusted Earnings.  The earnings of a business after adjustments for excess owner compensation, owner discretionary expenses, one-time or extraordinary expenses, and any other expenses that are not essential for the successful ongoing operation of the business.

Amortization. 1. The paying off of a debt in a series of installments over a period of time, such as a bank loan or mortgage. 2. A method of allocating the cost of an intangible asset over its useful life. Businesses amortize intangible assets such as franchise rights, patents, loan fees, and organizational costs.

Asset Approach.  A way of estimating the value of a business ownership interest using one or more Valuation Methods based on the Adjusted Book Value of the company.

Asset Sale.  A form of business sale or acquisition whereby a selling entity agrees to sell all or certain assets and liabilities of a company to a buyer.  The corporate entity is not transferred.  Contrast with Stock Sale.

Base Year.  The company’s current fiscal year.  Since complete financial statements are not available for the current year, sales and income are projected based on the expectations of management.

Blue Sky.  Any intangible portion of a price, above the maximum Goodwill, that cannot be reasonably supported through the application of established Valuation Methods.

Book Value.  The value, net of depreciation, at which an asset appears on a company’s balance sheet.

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Capital Structure.  The mix of invested equity and debt financing of a business enterprise.

Capitalization Rate.  Any multiple or divisor used to convert a single period (usually a year) of anticipated economic benefits into a present economic value.

Capitalizing Net Income.  Determining the value of a company by dividing one year of Adjusted Earnings by the Capitalization Rate (investor’s required ROI).

Cash Flow.  See Sellers Discretionary Earnings below.

Deal Structure.  The combination of types of payment or consideration by which the purchase of a business is accomplished.  It can include cash, promissory notes, stock, consulting agreements, covenants not to compete, earnout provisions and the assumption of debt.  The sale can take the form of an Asset Sale or a Stock Sale.

Depreciation. A method of allocating the cost of a tangible asset over its useful life. Businesses depreciate long-term assets for both tax and accounting purposes. The rate at which an asset is depreciated is computed by dividing the depreciable cost of the asset by the number of years in the asset’s estimated productive or useful life.

Discount Rate.  A rate of return used to calculate the present value of multiple periods (usually years) of payments.

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Earnout.  The portion of the purchase price that is contingent on the future performance of the business.  It is payable to the seller after certain predefined levels of sales or income are achieved in the year(s) after acquisition.

EBITDA.  Earnings Before Interest Taxes Depreciation and Amortization.  It can be used to analyze and compare profitability between companies and industries because it eliminates the effects of financing and accounting decisions.

Fair Market Value.  The estimated price at which an asset or service would pass from a willing seller to a willing buyer, assuming that both buyer and seller are acting rationally, at arms length, in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts.  It is also presumed that the price is not affected by special or creative financing or sales concessions granted by anyone associated with the sale.

Fixed Interest Rate.  An interest rate that does not fluctuate over the term of the loan.  Contrast with Variable Interest Rate.

Going Concern Value.  The gross value of a company as an operating business.  This value may exceed or be at a discount from the Liquidation Value.  The intangible elements of Going Concern Value result from factors such as having a trained work force, an operational plan and the necessary licenses, systems and procedures in place.

Goodwill.  The amount by which the price paid for a company exceeds the company’s Adjusted Book Value of the underlying tangible assets and liabilities.  Goodwill is a result of name, reputation, customer loyalty, location, products and net income.

Income (Income Based) Approach.  General way of determining the value of a business, business ownership interest, security or intangible asset using one or more methods that calculate the present value of anticipated future income.

Interest.  Fee charged by a lender to a borrower in exchange for the use of borrowed money over time.  See Fixed Interest Rate and Variable Interest Rate.

Intrinsic Value.  An analytical judgment of value based on the perceived characteristics inherent in the investment as distinguished from the current market price.

Investment Value.  The value to a particular investor based on individual investment requirements and expectations.

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Liquidation or Liquidating Value.  The estimated value, net of liabilities, of a company based on the market value of its assets.

Market (Market Based) Approach.  General way of determining a value indication of a business, business ownership interest, security or intangible asset by using one or more methods that compare the subject to similar businesses, business ownership interests, securities or intangible assets that have been sold.

Net Book Value.  With respect to a business enterprise, the difference between total assets (net of depreciation, depletion and amortization) and total liabilities as they appear on the balance sheet (synonymous with Shareholder’s Equity).  With respect to a specific asset, the capitalized cost less accumulated amortization or depreciation as it appears on the books of account of the business enterprise.

Present Value. The value today of a future payment, or stream of payments, discounted at some appropriate compound interest rate (Discount Rate).

Pro Forma Financial Statements.  Hypothetical financial statements.  Financial statements as they would appear if some event, such as increased sales or production, had occurred or were to occur.  Also used to make projections for future years.

Projection.  Prospective financial statements that present an entity’s expected financial position, results of operation and changes in financial position, based upon one or more hypothetical assumptions.

Recasting.  Financial recasting eliminates, from the historical financial presentation, items such as excessive and discretionary expenses and nonrecurring revenues and expenses, since they reflect the financing decisions of the current owner and may not represent financing preferences of a new owner.  Recasting provides an economic view of the company and allows meaningful comparisons with other investment opportunities.

Residual Value.  The estimated market value of an asset at the end of the period being considered.

Return on Investment (ROI).  The rate of return at which the sum of the discounted future earnings plus the discounted future Residual Value equals the initial cash outlay.

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Sellers Discretionary Earnings (SDE).  (also Cash Flow).  Total financial benefit to one owner/operator working full-time in the business enterprise.  Out of the SDE, an owner must pay himself a salary, make loan payments, pay his company’s income taxes, pay for any capital improvements (if needed) and set aside funds for unexpected events.  It is calculated by adding the following expenses back to the Net Income of the business:

Net Income
+ Interest
+ Taxes
+ Depreciation
+ Amortization
+ Owner’s Compensation
+ Owner’s Fringe Benefits
+ One-Time Expenses
= Sellers Discretionary Earnings (SDE)

Stock Sale.  A form of business sale or acquisition whereby all or a portion of the stock in a corporation is sold to the buyer.  Contrast with Asset Sale.

Tax Basis. In a business sale, the taxable amount is the difference between the tax basis and the proceeds from the sale.  The tax basis is generally the original cost for the asset, minus depreciation, minus any write-offs or write-downs, and plus any capital improvements and plus the business sale transaction expenses (i.e. attorney, accountant, broker).

Transaction Value.  Total of all consideration passed at any time between the buyer and seller for an ownership interest in a business enterprise and may include but is not limited to all remuneration for tangible and intangible assets such as: furniture, fixtures, equipment, inventory, Working Capital, non-competition agreements, customer lists, employment and/or consulting agreements, franchise fees, assumed liabilities, stock options or redemptions, real estate, leases, royalties, Earnouts and future considerations.

Valuation Approach.  A general way of determining a value indication of a business, business ownership interest, security or intangible asset using one or more Valuation Methods.  There are three overall approaches generally used to value a business: Asset Approach, Income Approach and Market Approach.

Valuation Method.  Under a chosen Valuation Approach, there are various specific methods to determine value.

Variable Interest Rate.  An interest rate that adjusts periodically to a predefined margin above or below an index rate.  A commonly used index rate is the Wall Street Journal Prime Rate.  Contrast with Fixed Interest Rate.

Working Capital.  The excess of current assets over current liabilities.

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