Modern business valuations have come a long way from the days of guessing and using the back-of-the-envelope calculation. Small business owners or their brokers want a valuation before putting a company on the market to ensure they get the correct value for their company.
However, business valuations are not an exact science. The value of a small business or large business is ultimately what someone is willing to pay for it. But there are methods and factors that company appraisers use to calculate what a company is worth. In that sense, there are objective and subjective aspects to business valuations.
This article will discuss the different methods used to value a business and how to value a business in its present value when you’re ready to sell. We will also touch on objective and subjective factors that affect a business’s value.
What Is Business Valuation?
Business value is the economic worth of a company to its owner or shareholders. Its value can be different from the book value, which tallies all of the company’s assets and subtracts all of its liabilities. A business’s value also considers intangible factors such as the company’s reputation, brand, and intellectual property.
Business valuation is the process of determining what a company is worth. This can be done for many reasons, such as:
- Selling or buying: The most common reason business owners want to know their company’s value is because they are thinking about selling. Whether working with a business broker or going alone, you’ll want to set a fair price for your business.
- Estate planning: If you own a small business, you’ll want to know its value for estate planning purposes. This will help ensure your loved ones are cared for after you’re gone.
- Shareholder disputes: Shareholders may disagree on the company’s worth if they want to sell. A business valuation can help settle these disputes.
- Financing: If you’re looking for funding, potential investors or lenders will want to know the value of your business before they provide any funding.
- Tax planning: Knowing the value of your company can help with tax planning. This is especially true for companies with high asset values.
Types of Business Valuations
There are three main types of business valuations: asset, market, and net income approaches. Let’s take a look at each one in more detail.
Asset Approach
The asset approach values a company based on the economic value of its assets. This includes both tangible and intangible assets. To calculate the value using this approach, you would add the value of all of the company’s assets and subtract any debts or liabilities.
Pros
The main advantage of the asset approach is that it’s relatively easy to calculate. You must determine the value of all the company’s assets and subtract any debts or liabilities.
Cons
The downside of this approach is that it doesn’t consider the company’s income or profitability. This means it could undervalue businesses that are not generating much revenue but are still profitable.
Market Approach
The market approach value is based on what similar companies have sold for. This approach is most commonly used for companies in the same industry. To calculate the value using this approach, you would look at recent sales of other companies and use those as a guide.
Pros
The market approach is based on sales data, making it more accurate to value a company.
Cons
While this method has its perks, one disadvantage is that tracking down comparable sales data can be tricky. This dilemma becomes especially prevalent for businesses operating in niche markets.
Income Approach
The income approach values a business based on its prospective profit potential. To calculate the value using this approach, you would estimate the company’s future earnings and discount them back to the present value.
Pros
The income approach has the distinct advantage of focusing on a company’s revenue potential. Because it evaluates businesses based on what they could earn, this method is more accurate than other ways of valuing companies.
Cons
A significant drawback of this approach is that it can be challenging to estimate a company’s future earnings. This is especially true for businesses with high growth potential.
How Are Businesses Valued?
Okay, so you’re ready to sell your business. Congratulations! This is a big decision and not one to be taken lightly. But now that you’ve decided to do so, it’s time to start thinking about how to value the business that will set you up for future success and help you get the best possible price for your company.
There are a few different ways to value a business, but using a business broker is the most common and accurate method. Business brokers are experts in valuing businesses and can help you determine a fair price for your company.
The first step in valuing your company is understanding what factors will affect your company’s value. These include things like:
- The size of your company
- The industry you’re in
- The location of your company
- The financial health of your company
- The growth potential of your company
Once you have a good understanding of these factors, you can start thinking about how they will affect your company’s value. For example, if you’re in a rapidly growing industry, your business will likely be worth more than a business in a declining industry.
Another essential factor to consider is the current market conditions. If there are more buyers than sellers in the market, your business will likely be worth more. Similarly, if there are more businesses for sale than buyers, your business will be worth less.
Once you’ve considered all of these factors, you can start to think about what your business is worth. This is where a business broker can be beneficial.
Other Methods for Valuing a Business
Business brokers aren’t the only ones who can help you value your business. Below are other practical business valuation methods for valuing a company.
1. Book Value
The book value of a business is the value of the business assets minus the liabilities. This is a good starting point for valuing a business, but it doesn’t consider things like intangible assets or future growth potential.
2. Discounted Cash Flow Method
Discounted cash flow (DCF) valuation process is a method of valuing a business that considers the company’s future cash flow. Investors often use this method to value companies, as it can give a more accurate picture of the potential future value of the business.
Cash flow can be difficult to predict, so this method is best used by businesses with a long history of financial stability. Discounted cash flow analysis is also a complex method and can be difficult to understand without the help of a professional.
3. Multiple Earnings
The multiple earnings method is a simple way to value based on a company’s past financial performance. This method uses a multiple (usually 12-18) of the business’s earnings to determine its value.
4. Market Comparables
Market comparables is a method of valuing a company that looks at companies that have been sold recently.
This can be a helpful way to value a business based on market value, but it’s essential to find comparable companies that are as similar as possible to your own. Fair market value is the most likely selling price of a business in an arms-length transaction between two knowledgeable and willing parties.
5. Asset Value
Asset value would be the value of the company’s assets if they were sold today. This method doesn’t consider future earnings potential or intangible assets, but it can be a good starting point for valuing a firm.
Conclusion
It’s important to note that there is no one right way to value a business. The method you choose will depend on your specific circumstances and available information.
Now that you know how to value a business, you can start thinking about what your firm is worth. If you’re unsure where to start, a business broker can help you determine a fair price for your company.
Getting the best possible price is essential when you’re ready to sell your company. Using a business broker is the most accurate way to value your company and ensure you get the best possible price. Future cash flow, market comparables, and asset value are other important factors to consider when valuing your company.
If you’re not familiar with a business valuation, contact us today to get started with professionals that can help you every step of the way!