Understanding how much a business is worth – and how it can be made more valuable – is of vital importance to anyone buying, selling or simply running a business.
This article will help you understand how businesses are valued, what affects business valuation, and different methods used to determine business value estimates.
Why value your business?
There are four main reasons for valuing a business. Understanding the valuation process can help you to:
- Improve its real or perceived value.
- Negotiate better terms.
- Choose an appropriate time to buy or sell a business.
- Complete a purchase more quickly.
What affects business valuation?
- Tangible assets – stock, land and equipment.
- Reputation – although not a tangible asset, business reputation is important in valuing a business.
- Customers – a loyal customer base guarantees income levels and adds value to a business.
- Trademarks – trademarks can be valuable business property.
- Age – established businesses are valuable, but so are start-ups if they have potential.
- Revenue – if your business demonstrates ongoing growth, the perceived value is typically higher.
- Workforce – businesses with an established management team are seen as more dependable.
- Products and services – buyers look for high gross margins.
- Context of sale – whether the sale is voluntary or involuntary.
Different business valuation methods
Many different methods can be used to value a business. Often, multiple methods are combined to form a more complete picture of a company’s worth. Here are some of the most common business valuation methods:
- Price to earnings ratio.
- Valuing the business assets.
- Discounted cash flow.
Price to earnings ratio
This method of company valuation uses a ratio of price to earnings to determine the worth of a business. Using this method, the current share price of the business is related to its earnings per share. This method is used to analyse how the value of a business has changed over time. It can also be used to compare a company’s earnings to those of a competitor.
The price to earnings ratio is often referred to as the price multiple – a higher ratio suggests that investors expect higher earnings growth in the future. If someone is considering buying your business, they might use this ratio to determine whether your stock is under or overvalued. Because valuations and growth rates vary between industries, this ratio is not useful for comparing companies from different sectors.
Valuing the business assets
If your company is well established and owns many tangible assets, it’s fairly straightforward to assess its business value. For a realistic estimation of your company’s overall worth, you’ll have to adjust the value of each business asset to reflect economic reality.
To value your business using this method, you need to adopt a pragmatic approach. Maybe you’re still due money from a while ago, but you’re unlikely to ever receive it. In that case, you should deduct it from the value of your business.
Discounted cash flow
This method of business valuation depends on predictions about your company’s potential, so it’s best suited to companies that are already well established. After a while, a company’s cash flow becomes more stable and predictable. This historical data can be used to make informed projections about its future.
This is one of the more complex methods of company valuation. To calculate the profit of a company in today’s terms, you must establish a discount rate that takes into consideration both the risk involved and the “time value” of the money. The “time value” of money is a concept explaining that a sum of money is worth more today than it will be in the future because today it has future earning potential.
How much is my business worth?
Figuring out the value of your business requires some nuance, and cannot be defined by profit margins alone. That’s why it makes sense to combine techniques for a more accurate estimation. It’s helpful to ask yourself the following questions:
- What tangible assets does my business own, and what are they worth in reality?
- What intangible assets does my business own, and how can I ascribe a monetary value to them?
- Can I use my company’s past to make projections about its future growth, and what would that growth be worth in today’s money?
- What is my business’s price to earnings ratio, and using this, is my stock under or overvalued?
- How much would it cost to start up the same business today, and how much would I need to spend to get it to the level of success that my business currently enjoys?
- Has anyone offered me money for my business? If so, how much are they willing to pay for it?
- How does my company compare to others in my industry, and how is it performing against industry standards?
Why do you need a solicitor for a business sale/purchase?
Buying or selling a business is big thing for many people, and not something that all clients have done before. If you’ve not, then you need more than just excellent legal support; you need sound business advice as well. Reach out for expert advice to to make this process as straightforward as possible and ensure that you fulfill all your statutory obligations.