BUSINESS VALUATION METHODS-ALL YOU NEED TO KNOW
A business valuation is the process of determining a company’s economic value. Professional evaluators are typically brought in to determine the value of the business, using one or more valuation methods to arrive at an objective number. At the most basic level, business valuation is the process by which the economic worth of a company is determined.
As we mentioned, there are different approaches to evaluating the value of a small business, but generally, each method will involve a full and objective assessment of every piece of your company. This being said, business valuation calculations typically include the worth of your equipment, inventory, property, liquid assets, and anything else of economic value that your company owns. Other factors that might come into play are your management structure, projected earnings, share price, revenue, and more.
Reasons for Performing a Business Valuation:
Business valuation to a company is an important exercise since it can help in improving the company. Here are some of the reasons to perform a business valuation.
Litigation
During a court case such as an injury case, divorce, or where there is an issue with the value of the business, you may need to provide proof of your company’s worth so that in case of any damages, they are based on the actual worth of your businesses and not inflated figures estimated by a lawyer.
Exit strategy planning
In instances where there is a plan to sell a business, it is wise to come up with a base value for the company and then come up with a strategy to enhance the company’s profitability so as to increase its value as an exit strategy. Your business exit strategy needs to start early enough before the exit, addressing both involuntary and voluntary transfers.
A valuation with annual updates will keep the business ready for unexpected and expected sale. It will also ensure that you have correct information on the company fair market value and prevent capital loss due to lack of clarity or inaccuracies.
Buying a business
Even though sellers and buyers usually have diverse opinions on the worth of the business, the real business value is what the buyers are willing to pay. A good business valuation will look at market conditions, potential income, and other similar concerns to ensure that the investment you are making is viable. It may be prudent to hire a business broker who can help you with the process.
Selling a business
When you want to sell your business or company to a third party, you need to make certain that you get what it is worth. The asking price should be attractive to prospective purchasers, but you should not leave money on the table.
Strategic planning
The true value of assets may not be shown with a depreciation schedule, and if there has been no adjustment of the balance sheet for various possible changes, it may be risky. Having a current valuation of the business will give you good information that will help you make better business decisions.
Funding
An objective valuation is usually needed when you need to negotiate with banks or any other potential investors for funding. Professional documentation of your company’s worth is usually required since it enhances your credibility to the lenders.
Selling a share in a business
For business owners, proper business valuation enables you to know the worth of your shares and be ready when you want to sell them. Just like during the sale of the business, you ought to ensure no money is left on the table and that you get good value from your share.
Business Valuation Methods:
Asset Valuation
Your company’s assets include tangible and intangible items. Use the book or market value of those assets to determine your business’s worth. Count all the cash, equipment, inventory, real estate, stocks, options, patents, trademarks, and customer relationships as you calculate the asset valuation for your business.
Historical Earnings Valuation
A business’s gross income, ability to repay debt, and capitalization of cash flow or earnings determines its current value. If your business struggles to bring in enough income to pay bills, its value drops. Conversely, repaying debt quickly and maintaining a positive cash flow improves your business’s value. Use all of these factors as you determine your business’s historical earnings valuation.
Relative Valuation
With the relative valuation method, you determine how much a similar business would bring if they were sold. It compares the value of your business’s assets to the value of similar assets and gives you a reasonable asking price.
Capitalization of Earnings Valuation Method
Next, the capitalization of earnings valuation method calculates a business’s future profitability based on its cash flow, annual ROI, and expected value.
This approach, unlike the DCF method, works best for stable businesses, as the formula assumes that calculations for a single time period will continue. In this way, this method bases a business’s current value on its ability to be profitable in the future.
Discount Cash Flow Valuation
If profits are not expected to remain stable in the future, use the discount cash flow valuation method. It takes your business’s future net cash flows and discounts them to present day values. With those figures, you know the discounted cash flow valuation of your business and how much money your business assets are expected to make in the future.
Book Value Valuation Method
Finally, the book value method calculates the value of your business at a given moment in time by looking at your balance sheet. With this approach, your balance sheet is used to calculate the value of your equity—or total assets minus total liabilities—and this value represents your business’s worth. The book value approach may be particularly useful if your business has low profits, but valuable assets.