None of the financial statements will report the value of a business. The main financial statements (balance sheet, income statement, statement of cash flows, statement of stockholders’ equity) may provide some helpful partial information, but they will not report the value of the business.
Two reasons why the value of a business is not included in the financial statements are:
- The financial statements are generally based on the company’s past recorded transactions. The value of the business will more likely be based on the perceived future transactions.
- The accountants’ cost principle prohibits a business from reporting some highly-valued assets such as trademarks, brand names, and an effective management team (assuming these were developed internally).
A contemporary example which demonstrates that the financial statements do not reflect the value of a business is a startup company with a promising future. We may have read that a venture capitalist (VC) invested $10 million in a startup. Based on that investment the startup is assumed to have a total value of $100 million. Well the startup’s financial statements will not report amounts anywhere near $100 million. Realistically the financial statements will be reporting negative earnings, few assets and little stockholders’ equity. The company’s value came from the VC’s perception of the company’s new breakthrough system that is projected to generate amazing future revenues with a limited amount of expenses.
In short, the financial statements provide only some of the information needed when attempting to determine the value of a business.
