Business Valuation Language Similarities and Differences

 A term may have a certain well-accepted definition in the lexicon of finance and security analysis and a different and equally well-accepted definition in the lexicon of real estate appraisal. Similarly, practitioners in business finance and security analysis may label a concept with one name, and practitioners in real estate appraisal may identify the same concept by some other name. The lexicon of business valuation / Business Appraisal logically follows the language of finance and security analysis since the common subject matter is operating businesses.

For example, under generally accepted accounting principles (GAAP), the term net operating income is typically defined to be income after the deduction of depreciation and amortization, and the literature of finance follows the accounting definition. By contrast, real estate terminology does not include noncash items such as depreciation or amor- tization in its definition of operating expenses. Therefore, the definition of net operating income as used in real estate terminology is a measure of economic income before deduction of depreciation or amortization expense.

In business finance and security analysis terminology, the term cash flow is commonly used to mean net income after all cash expenses, which means after interest costs but before noncash items such as de- preciation and amortization.' However, in real estate terminology, cash flow is typically defined as net operating income minus annual debt ser- vice (with debt service encompassing both principal and interest pay- ments). It is beyond the scope of this short article to provide a comparative lexicon of terminology used in the fields of real estate and business valuation / Business Appraisal. Our hope is that the foregoing examples will alert both analysts and business valuation users to the potential for miscommunication. The ambiguities prevalent in current usage are responsible both for miscommunications and for many erroneous appraisal results. Typically, real estate appraisals estimate the market value of the subject real estate—that is, an estimate of the price of the property if it was sold separately from the existing business. The value of real estate as part of a going-concern business is more accurately defined as use value.

In fact, The Appraisal of Real Estate indicates, "In estimating use value, the appraiser focuses on the value the real estate contributes to the enterprise of which it is part, without regard to the property's high- est and best use or the monetary amount that might be realized from its sale.Accordingly, it is not unusual for the market value of a piece of real estate to be quite different from its use value. An example of this situa- tion would be an old-fashioned factory still in use by the original manu-facturing company—to which it has considerable use value—that would require substantial renovation to be productive for another use. In this case, the factory would have a lower market value than it would a use value.