Top Mistakes in Business Valuation Reports That Keep Them a Mystery

By Heather Deskins, CPA/ABV/CFF, CFE, CVA

Having conducted valuations of businesses for the past 16 years, for various reasons, including litigation, I’ve also read my fair share of these lengthy reports. I will be the first to admit that reading a valuation report from cover to cover is not always the most stimulating. However, if you read it like a mystery novel, it can become slightly more intriguing. A valuation report should tell a story about the subject company being valued. The story may not be in sequential order, as oftentimes it tells you the conclusion in the first few pages; but figuring out how they reached that conclusion, is the mystery.

After reading a business valuation report, if the report is still a mystery and you are uncertain how the value was reached, there might have been some valuation mistakes made along the way. In this article, I will address the top valuation mistakes, I have come across, as well as try to avoid in my own reports.

Failing to Provide Explanations

A business valuation report should include the subject company’s historical financial statements, including the balance sheet and income statement. In the process of conducting a business valuation, the valuator may find it necessary to make certain adjustments to the historical financial statements. For example, if a related party owns the real estate the subject business operates from and the rent paid to the related party is three-times the normal rates, the valuator may adjust rent expenses down to current market levels. If the valuator fails to explain the reasoning behind the adjustment or provide adequate support for the adjustment, the mystery doesn’t get solved. They’ve just added another layer of uncertainty. Failing to provide adequate explanations and thought processes is a common valuation mistake.

Misapplying Valuation Data

One of the most common errors I see in valuation reports is applying a post-tax ratio to a pre-tax earnings stream. This occurs frequently with pass-through entities (S-Corporations or Partnerships), where the pass-through entity does not pay their own income taxes. Unless you know what to look for, this can be easily overlooked and it may have the largest impact on the valuation.

Another example of misapplying valuation data involves using a Market Method and not understanding the value the market multiple generates. Oftentimes, the market multiple arrives at a value of just fixed assets and goodwill and doesn’t include the value of real estate, inventory, accounts receivable and any liabilities. It’s important to understand the data being used and how it should be applied. The valuation report should provide enough detail about the data used, whereas the reader can follow and understand the application of the data.

Heather Deskins, CPA/ABV/CFF, CFE, CVA

Heather Deskins,

Managing Member
P.D. Eye Forensics, LLC