Business Valuation Applications to Economic Damages for Lost Profits
| Publication year | 2011 |
| Pages | 25 |
| Citation | Vol. 24 No. 1 Pg. 25 |
Vol. 24, No. 1, 25. Business Valuation Applications to Economic Damages for Lost Profits
Volume 24 No. 1
Jan/Feb 2011
This article is meant to convey the similarity of education, knowledge, skills, and training used in valuing a business with those needed for estimating lost profits a business may sustain. This skill set is held by a niche group of professionals, typically accountants, who have training and experience in matters related to business valuation and expert witness services. Qualified experts need to have a solid understanding of business valuation, accounting, finance, and other principles that are generally accepted in the expert community and need to use reliable principles and methods to ensure the highest level of client service and to have their work accepted by courts.
The Relationship Between Estimating Lost Profits and Business Valuation
A business valuation performed by a Certified Public Accountant is subject to the requirements of the Statement on Standards for Valuation Services promulgated by the American Institute of Certified Public Accountants ("AICPA").
A business valuation typically focuses on three approaches to arrive at a conclusion of value: (1) the asset approach, (2) the market approach, and (3) the income approach. Using these approaches, a business valuation is typically meant to arrive at a value for a business as a whole or a fractional ownership thereof. A detailed review of the various approaches and methods within each approach are outside the scope of this article. However, principles of the income approach form the basis of much of a lost profits calculation. The income approach is succinctly summarized as follows:
Frank K. Reilly, Investment Analysis and Portfolio Management 434 (5th ed. 1997)the value of an asset is the present value of its expected returns. Specifically, you expect an asset to provide a stream of returns during the period of time that you own it. To convert this estimated stream of returns to a value for the security you must discount this stream at your required rate of return. This process of valuation requires estimates of (1) the stream of expected returns, and (2) the required rate of return on the investment.
"Value today always equals future cash flow discounted at the opportunity cost of capital." Richard A. Brealey and Stewart C. Myers, Principles of Corporate Finance 73 (5th ed. 1996).
This approach is "the very heart of valuation." Shannon P. Pratt, Valuing a Business 152 (4th ed. 2000). Similarly, estimating lost profits requires the expert to estimate similar components: (1) the stream of lost profits and (2) an appropriate rate of return at which the lost...
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