{"id":930,"date":"2019-10-08T09:00:26","date_gmt":"2019-10-08T13:00:26","guid":{"rendered":"http:\/\/stage.tbkdev.com\/dev\/davismartindale.com\/src\/?p=930"},"modified":"2020-06-04T15:02:01","modified_gmt":"2020-06-04T19:02:01","slug":"introduction-to-rules-of-thumb-in-valuations","status":"publish","type":"post","link":"https:\/\/stage.tbkdev.com\/dev\/davismartindale.com\/src\/introduction-to-rules-of-thumb-in-valuations\/","title":{"rendered":"Introduction to Rules of Thumb in Valuations"},"content":{"rendered":"<div class=\"wpb-content-wrapper\"><p>[vc_row][vc_column][alternating_content_container]\t<div class=\"alternating-content-item-wrapper bg-light\">\n\t\t\t\t\t\t\t\t\t<div class=\"alternating-content-item-image center-center\" style=\"background-image: url('https:\/\/stage.tbkdev.com\/dev\/davismartindale.com\/src\/app\/uploads\/2019\/10\/Thumbs-Up-Part-1-LG-800x533.png'); background-size: cover;\"><\/div>\n\t\t\t\t\t\t\t<div class=\"alternating-content-item-content-container\">\n\t\t\t<div class=\"alternating-content-item-inner\">\n\t\t\t\t\t\t\t\t\t<span class=\"alternating-content-item-decor\">\n\t\t\t\t\t\tBlog\t\t\t\t\t<\/span>\n\t\t\t\t\t\t\t\t\t\t\t\t\t<h2 class=\"alternating-content-item-heading\">\n\t\t\t\t\t\tIntroduction to Rules of Thumb in Valuations\t\t\t\t\t<\/h2>\n\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t<div class=\"alternating-content-item-content\">\n\t\t\t\t\t\t<p>Applying rules of thumb to value business interests have a long and widely used history within the business community. In an effort to reduce the costs of preparing a formal valuation report, many business stakeholders use industry benchmarks or rules of thumb to calculate ballpark values of their business interests.<\/p>\n\t\t\t\t\t\t\t\t\t\t\t<\/div>\n\t\t\t\t\t\t\t\t\t\t\t<\/div>\n\t\t<\/div>\n\t<\/div>\n[\/alternating_content_container][basic_container container_size=&#8221;container container-narrow&#8221;][vc_column_text]In limited circumstances, the rule of thumb technique can be effective \u2013 it enables stakeholders to quickly and cost-efficiently calculate a rough value of their business. However, when dealing in situations that require a more technical and precise value, such as transactions, estate planning, and litigation, relying on rules of thumb instead of accepted valuation techniques may materially over or undervalue business interests.<\/p>\n<h4>What is a Rule of Thumb Valuation Approach?<\/h4>\n<p>Merriam-Webster dictionary defines a\u00a0<em>rule of thumb<\/em>\u00a0as:<\/p>\n<ol>\n<li>A method of procedure based on experience and common sense.<\/li>\n<li>A general principal regarded as roughly correct but not intended to be scientifically accurate.<\/li>\n<\/ol>\n<p>For valuation purposes, a rule of thumb involves applying an industry-specific multiple to an economic benefit, such as business revenue or discretionary cash flow. For example:<\/p>\n<ul>\n<li>A businesses\u2019 goodwill may be worth 2.0x discretionary cash flow; or<\/li>\n<li>An accounting practice\u2019s value may be worth 1.0x to 1.35x annual revenue plus work-in-process inventory(1).<\/li>\n<\/ul>\n<p>These rules of thumb are traditionally derived from a combination of experience, observations, hearsay, and real-world market transactions.<\/p>\n<h4>The Problem with Rules of Thumb<\/h4>\n<p>Consider a Toronto-based business owner who sells a minority interest of their business for the implied price of 5x Earnings Before Interest and Taxes (\u201cEBIT\u201d). During an informal discussion at a conference two years later, this multiple is discussed with another industry participant who operates a similar, but less profitable, business in a small town in Quebec. Relying on this information, the Quebec operator decides to price their business using the same 5x EBIT multiple.<\/p>\n<p>The only commonality between the two businesses is that they operate in the same industry. A proper valuation approach may consider the company\u2019s size, underlying assets, income or cash flow, economic and industry conditions, competitive advantages, and other unique factors when determining the appropriate value. The rule of thumb method, on the other hand, considers none of these factors.<\/p>\n<h4>Rules of Thumb in Formal Valuation Reports<\/h4>\n<p>In certain circumstances, Chartered Business Valuators (\u201cCBV\u201d) may apply rules of thumb to formal business valuations. However, unlike in our example above, CBVs traditionally use an earnings or cash flow-based approach as a primary valuation methodology, and then consider rules of thumb as a secondary check.<\/p>\n<p>If the conclusions from the rule of thumb test are\u00a0<em>not<\/em>\u00a0consistent with the CBV\u2019s expectations, this may indicate that further understanding and analysis is required, or that a revision to the primary valuation methodology may be needed. Rules of thumbs are however, rarely used as the primary method of calculation.<\/p>\n<h4>Conclusion<\/h4>\n<p>Rules of thumb offers a unique valuation tool to business stakeholders \u2013 the opportunity to quickly and cost-efficiently calculate a ballpark value of their enterprise. And while useful in limited contexts, stakeholders should be cautious to avoid undo reliance on these methods in place of commonly accepted valuation techniques.<\/p>\n<p>As always, it is important to understand the inner workings, and limitations, of any valuation approach used.<\/p>\n<p><strong>If you have found yourself in a situation that requires a formal valuation report,\u00a0<a href=\"http:\/\/stage.tbkdev.com\/dev\/davismartindale.com\/src\/services\/business-valuation-services\/\">give the experts at Davis Martindale a call<\/a>. We\u2019d love to work with you.<\/strong><\/p>\n<p>You may also be interested in Part 2 in this series:\u00a0<a href=\"http:\/\/stage.tbkdev.com\/dev\/davismartindale.com\/src\/application-of-rules-of-thumb\/\">Application of Rules of Thumb in Court<\/a>[\/vc_column_text][\/basic_container][\/vc_column][\/vc_row][vc_row][vc_column][basic_container container_size=&#8221;container container-narrow&#8221;]<div class=\"templatera_shortcode\"><div class=\"vc_row wpb_row vc_row-fluid\"><div class=\"wpb_column vc_column_container vc_col-sm-12\"><div class=\"vc_column-inner\"><div class=\"wpb_wrapper\"><div class=\"basic-container row   \" >\n\t<div class=\"bg-overlay none\"><\/div>\n\t<div class=\"container\">\n\t\t\t<div class=\"text-left\">\n\t\t<a class=\"general-button btn  btn-info \" href=\"https:\/\/stage.tbkdev.com\/dev\/davismartindale.com\/src\/subscribe\/\" rel=\"\" target=\"\" title=\"Subscribe\">\n\t\t\tSubscribe to Davis Martindale's Valuation 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center;\"><a href=\"http:\/\/stage.tbkdev.com\/dev\/davismartindale.com\/src\/team-members\/ron-martindale\/\">Ron Martindale<\/a><\/h5>\n<p style=\"text-align: center;\">BASc, CPA, CA, LPA, CBV, CFF<strong><br \/>\nPartner<br \/>\nValuation &amp; Litigation<\/strong><\/p>\n\n\t\t<\/div>\n\t<\/div>\n<\/div><\/div><\/div><div class=\"wpb_column vc_column_container vc_col-sm-3\"><div class=\"vc_column-inner\"><div class=\"wpb_wrapper\"><!DOCTYPE html PUBLIC \"-\/\/W3C\/\/DTD HTML 4.0 Transitional\/\/EN\" \"http:\/\/www.w3.org\/TR\/REC-html40\/loose.dtd\">\n<html><body><div class=\"wpb_single_image wpb_content_element vc_align_center wpb_content_element\">\n\t\t\n\t\t<figure class=\"wpb_wrapper vc_figure\">\n\t\t\t<div class=\"vc_single_image-wrapper vc_box_border  vc_box_border_grey\"><img decoding=\"async\" class=\"vc_single_image-img \" src=\"https:\/\/stage.tbkdev.com\/dev\/davismartindale.com\/src\/app\/uploads\/2020\/03\/Tyler-Kelly-2-2020-200x200.jpg\" width=\"200\" height=\"200\" alt=\"Head shot of Tyler\" title=\"Tyler Kelly - Valuation Associate - Davis Martindale\" loading=\"lazy\"><\/div>\n\t\t<\/figure>\n\t<\/div>\n<\/body><\/html>\n\n\t<div class=\"wpb_text_column wpb_content_element\" >\n\t\t<div class=\"wpb_wrapper\">\n\t\t\t<h5 style=\"text-align: center;\"><a href=\"http:\/\/stage.tbkdev.com\/dev\/davismartindale.com\/src\/team-members\/tyler-kelly\/\">Tyler Kelly<\/a><\/h5>\n<p style=\"text-align: center;\">CPA<strong><br \/>\n<\/strong><strong>Associate<br \/>\nValuation<\/strong><\/p>\n\n\t\t<\/div>\n\t<\/div>\n<\/div><\/div><\/div><div class=\"wpb_column vc_column_container vc_col-sm-3\"><div class=\"vc_column-inner\"><div class=\"wpb_wrapper\"><\/div><\/div><\/div><div class=\"wpb_column vc_column_container vc_col-sm-3\"><div class=\"vc_column-inner\"><div class=\"wpb_wrapper\"><\/div><\/div><\/div><\/div>\n\t<\/div>\n<\/div>\n<\/div><\/div><\/div><\/div><\/div>[\/basic_container][vc_empty_space][basic_container container_size=&#8221;container container-narrow&#8221;][vc_column_text]<strong>Information Sources:<\/strong><\/p>\n<ul>\n<li>1 \u2013 Business Brokerage Press, 2018 Business Reference Guide<\/li>\n<\/ul>\n<p>[\/vc_column_text][\/basic_container][vc_empty_space]<div class=\"templatera_shortcode\"><div class=\"vc_row wpb_row vc_row-fluid\"><div class=\"wpb_column vc_column_container vc_col-sm-12\"><div class=\"vc_column-inner\"><div class=\"wpb_wrapper\">\t<div class=\"row\">\n\t\t<div class=\"general-cta background-image-loading   image   bg-center\"  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class=\"post-listing__item\" href=\"https:\/\/stage.tbkdev.com\/dev\/davismartindale.com\/src\/business_valuation_engagement_joint_retainer\/\">\r\n\t\t\t\t<div>\r\n\t\t\t\t\t\t\t\t\t\t\t<div class=\"post-listing__item__image\" style=\"background-image: url(https:\/\/stage.tbkdev.com\/dev\/davismartindale.com\/src\/app\/uploads\/2020\/06\/Engagement-Process-Part-2-768x768.png)\"><\/div>\r\n\t\t\t\t\t\r\n\t\t\t\t\t<h2 class=\"h3 post-listing__item__title\">\r\n\t\t\t\t\t\tThe Process of a Business Valuation \u2013 Engagement by Multiple Parties\t\t\t\t\t<\/h2>\r\n\r\n\t\t\t\t\t\r\n\t\t\t\t\t<p>Chartered Business Valuators (\u201cCBV\u201d) are often jointly retained by parties in an attempt to identify and resolve issues in dispute. When properly conducted, joint engagements ...<\/p>\n\t\t\t\t<\/div>\r\n\t\t\t\t\t\t\t\t\t<span class=\"btn btn-primary btn-sm post-listing__item__button\">Read More<\/span>\r\n\t\t\t\t\t\t\t<\/a>\r\n\t\t\t\t\t\t\t\t<a class=\"post-listing__item\" href=\"https:\/\/stage.tbkdev.com\/dev\/davismartindale.com\/src\/business_valuation_engagements\/\">\r\n\t\t\t\t<div>\r\n\t\t\t\t\t\t\t\t\t\t\t<div class=\"post-listing__item__image\" style=\"background-image: url(https:\/\/stage.tbkdev.com\/dev\/davismartindale.com\/src\/app\/uploads\/2020\/06\/Engagement-Process-Part-1-747x747.png)\"><\/div>\r\n\t\t\t\t\t\r\n\t\t\t\t\t<h2 class=\"h3 post-listing__item__title\">\r\n\t\t\t\t\t\tThe Process of a Business Valuation \u2013 Engagement by One Party\t\t\t\t\t<\/h2>\r\n\r\n\t\t\t\t\t\r\n\t\t\t\t\t<p>You\u2019ve decided to engage a Chartered Business Valuator (\u201cCBV\u201d) to value your business. Perhaps you\u2019re looking to\u00a0sell your business\u00a0and want to get an idea what ...<\/p>\n\t\t\t\t<\/div>\r\n\t\t\t\t\t\t\t\t\t<span class=\"btn btn-primary btn-sm post-listing__item__button\">Read More<\/span>\r\n\t\t\t\t\t\t\t<\/a>\r\n\t\t\r\n\t\t\t\t\t<div class=\"blogs-paging\">\r\n\t\t\t\t<div class=\"nav-previous\"><\/div>\r\n\t\t\t\t<div class=\"blog-page-count\">\r\n\t\t\t\t\t<a class=\"page-count-link\" href=\"https:\/\/stage.tbkdev.com\/dev\/davismartindale.com\/src\/wp-json\/wp\/v2\/posts\/930\/\">1<\/a><a class=\"page-count-link\" href=\"https:\/\/stage.tbkdev.com\/dev\/davismartindale.com\/src\/wp-json\/wp\/v2\/posts\/930\/page\/2\/\">2<\/a><a class=\"page-count-link\" href=\"https:\/\/stage.tbkdev.com\/dev\/davismartindale.com\/src\/wp-json\/wp\/v2\/posts\/930\/page\/3\/\">3<\/a><a class=\"page-count-link\" href=\"https:\/\/stage.tbkdev.com\/dev\/davismartindale.com\/src\/wp-json\/wp\/v2\/posts\/930\/page\/4\/\">4<\/a><a class=\"page-count-link\" href=\"https:\/\/stage.tbkdev.com\/dev\/davismartindale.com\/src\/wp-json\/wp\/v2\/posts\/930\/page\/5\/\">5<\/a><a class=\"page-count-link\" href=\"https:\/\/stage.tbkdev.com\/dev\/davismartindale.com\/src\/wp-json\/wp\/v2\/posts\/930\/page\/6\/\">6<\/a><a class=\"page-count-link\" href=\"https:\/\/stage.tbkdev.com\/dev\/davismartindale.com\/src\/wp-json\/wp\/v2\/posts\/930\/page\/7\/\">7<\/a><a class=\"page-count-link\" href=\"https:\/\/stage.tbkdev.com\/dev\/davismartindale.com\/src\/wp-json\/wp\/v2\/posts\/930\/page\/8\/\">8<\/a><a class=\"page-count-link\" href=\"https:\/\/stage.tbkdev.com\/dev\/davismartindale.com\/src\/wp-json\/wp\/v2\/posts\/930\/page\/9\/\">9<\/a><a class=\"page-count-link\" href=\"https:\/\/stage.tbkdev.com\/dev\/davismartindale.com\/src\/wp-json\/wp\/v2\/posts\/930\/page\/10\/\">10<\/a><a class=\"page-count-link\" href=\"https:\/\/stage.tbkdev.com\/dev\/davismartindale.com\/src\/wp-json\/wp\/v2\/posts\/930\/page\/11\/\">11<\/a><a class=\"page-count-link\" href=\"https:\/\/stage.tbkdev.com\/dev\/davismartindale.com\/src\/wp-json\/wp\/v2\/posts\/930\/page\/12\/\">12<\/a><a class=\"page-count-link\" href=\"https:\/\/stage.tbkdev.com\/dev\/davismartindale.com\/src\/wp-json\/wp\/v2\/posts\/930\/page\/13\/\">13<\/a><a class=\"page-count-link\" href=\"https:\/\/stage.tbkdev.com\/dev\/davismartindale.com\/src\/wp-json\/wp\/v2\/posts\/930\/page\/14\/\">14<\/a><a class=\"page-count-link\" href=\"https:\/\/stage.tbkdev.com\/dev\/davismartindale.com\/src\/wp-json\/wp\/v2\/posts\/930\/page\/15\/\">15<\/a><a class=\"page-count-link\" href=\"https:\/\/stage.tbkdev.com\/dev\/davismartindale.com\/src\/wp-json\/wp\/v2\/posts\/930\/page\/16\/\">16<\/a><a class=\"page-count-link\" href=\"https:\/\/stage.tbkdev.com\/dev\/davismartindale.com\/src\/wp-json\/wp\/v2\/posts\/930\/page\/17\/\">17<\/a>\t\t\t\t<\/div>\r\n\t\t\t\t<div class=\"nav-next\"><a href=\"https:\/\/stage.tbkdev.com\/dev\/davismartindale.com\/src\/wp-json\/wp\/v2\/posts\/930\/page\/2\/\" >Next<\/a><\/div>\r\n\t\t\t<\/div>\r\n\t\t\t<\/div>\r\n[\/basic_container][vc_empty_space][\/vc_column][\/vc_row][vc_row][vc_column][\/vc_column][\/vc_row]<\/p>\n<\/div>","protected":false},"excerpt":{"rendered":"Blog The Benefits and Pitfalls of Jointly Retained Engagements This blog outlines the six important steps to your business valuation engagement with Davis Martindale Advisory Services. You\u2019ve decided to engage a Chartered Business Valuator (\u201cCBV\u201d) to value your business. Perhaps you\u2019re looking to\u00a0sell your business\u00a0and want to get an idea what it may be worth. [...]","protected":false},"author":2,"featured_media":2884,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[12],"tags":[],"class_list":["post-930","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-valuation-blog"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v23.9 - https:\/\/yoast.com\/wordpress\/plugins\/seo\/ -->\n<title>Introduction to Rules of Thumb in Valuations - Davis Martindale Blog<\/title>\n<meta name=\"description\" content=\"In this blog, we discuss methods and circumstances around using Section 85 Tax Rollovers, and provide examples of how this rollover would work.\" \/>\n<meta name=\"robots\" content=\"noindex, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta 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