Why Should You Value Your Business?
Valuing your business is one of the most important steps in buying, selling, and growing any business. If you plan on selling your business, then calculating its value is a principal part of the process.
Of course, you can still value a business if you don’t plan on selling it. We encourage you to do this, as it will assist you in mapping out future developments, identifying weaknesses and maximising strengths in your business. Here are some common reasons why business owners decide to calculate a company’s worth:
Common reasons for valuing a business:
- You want to know your business's value before selling it
- You want to gain a better understanding of your business so you can have practical expectations for the selling or buying process
- You want to find where the strengths and weaknesses lie
- You want to identify areas that need improvement
- You want to determine if its success is sustainable
Getting a valuation has a lot of benefits, but it can be a challenging process. You will need to decide on appropriate methods that suit your business so you can secure the best buyer and receive a financial reward for all your hard work and investments.
This step-by-step guide will help you prepare for the valuation process by offering reasons, calculation methods, a few sector-specific valuation examples and professional support.
If you need to value a business quickly, we'll let you know what techniques and tools you can use to get a swift outcome. You may want to take your time and get a more detailed valuation, so we'll cover ways you can achieve this too. Reading through this guide will help you manage your expectations on how to value a small business.
What are the Benefits of Valuing a Business?
The purpose of a business valuation is to paint an accurate picture of your business's worth. Valuations consider some combination of the market value of assets, current and/or projected revenues and/or cash flow and other barometers of your business's health.
The main benefit of getting an accurate valuation is to receive granular insights into your business’s functionality and financial value.
Other benefits of calculating a business’s value include:
- Setting a credible asking price before selling the business
- Providing information that reassures buyers and reveals ways they can build further value
- To inform an exit strategy for growing, improving and eventually selling the business
- Securing capital investment from investors
- Setting the price of shares for purchase by employees
What Impacts a Business Valuation?
There will be different criteria that affect the value of a business, and they will vary in importance. These can range from your fair market value of tangible assets and your historical financial performance. Here are some basic impacting factors you will need to consider:
- The circumstance of the valuation: this may be a voluntary or forced sale. This can impact your valuation and power dynamic during negotiations.
- The value of your tangible assets: this can include cash, premises, land, machinery, furniture, stock, equipment and employees.
- The value of your intangible assets: valuations can account for historic and projected profits, revenues and cashflow. Projections are estimated based on your intangible assets such as the business's age, goodwill, intellectual property, and the business's core values and culture.
- The durability of these assets and wider economic conditions or external influences: for example, a gloomy economic outlook would not undermine the appeal of a recession-resilient business like a pawnbroker or convenience store. And a business whose revenues have been growing steadily over many years will offer the stability that is attractive to buyers.
- Reliance on the owner: a business owner should make themselves dispensable. If operations, processes and employees are too reliant on an owner, a company’s value can decrease.
- Business size: an accurate, fair market value of your business is important, so consider the size and sector of your business, including the type of product or service you offer. These factors will affect how your business is valued.
Understanding these factors will illustrate where your business is and how it can improve. It will also give potential buyers a comprehensive outline of your business's value so that they can manage the risk profile of your business.
Keep in mind that for some companies, high growth means that the value changes rapidly. If your business has grown significantly since you started it, you may be looking to bring in a partner. If this is the case, make sure you know what your equity and share value is.
Whether you are searching for potential buyers or developing your business, understanding what can impact your company valuation is essential.
Company Valuation Formula
So, let’s start understanding how to determine the value of a company using valuation formula.
Business owners will require different company valuation formula to understand the financial value of their business. Some may want to know how to value a company based on revenue, or how to value a business based on profit.
Naturally, how you value a small business (like a café) would differ from how you value Amazon or Apple. Most business valuations consider the value of physical assets and income and often draw on multiple valuation techniques.
For the purpose of this guide, we’ll offer two valuation methods: the asset-based method, and the cash-flow method.
The asset-based method
This approach is effective for businesses that are asset-rich, like a property investment firm or manufacturers. Used alone, it is also useful for businesses in liquidation.
The asset valuation method should include a fair market valuation (FMV) or a net-based value (NBV). It subtracts the total value of liabilities from the total value of business assets recorded on the balance sheet.
The resulting figure is then adjusted for factors such as changes in asset values, bad debt and ageing stock that must be sold at a discount. This approach does not consider future earnings or goodwill.
The cash-flow method
There are a few valuation derivatives that can be used in a cash-flow approach. These include:
• Seller's discretionary earnings
This method is useful for valuing owner-managed businesses. The SDE method considers your total cash flow including discretionary items like salaries, benefits, and depreciation. Remember to include your expenses in this method, like your rent and labour.
This method gives you a strong reflection of your business's profit potential by calculating what the business's earning would be with the buyer.
A comparable analysis is often used to compliment this method, whereby publicly available multiples of each industry are used to calculate a figure based on valuations of similar businesses.
• Price-to-earnings ratio (P/E ratio) and EBITDA
The price-to-earnings (or P/E) ratio method establishes the value of a company's earnings per share. Used to determine whether a limited company's stock price is overvalued or undervalued, it usually only applies to companies listed on the stock market.
Determining the most accurate number for your P/E ratio depends on your type of business. It is a good idea to compare your business's P/E ratio with others to find their relative value.
The acronym EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortisation. A company valuation based on EBITDA will look at the net earnings before any other facts are considered. Remember that this method ignores many factors that could impact the profitability of your business.
• Discounted cash flow
The discounted cash flow method calculates the present value of projected cash flows. This method is suitable for investor-based shareholders (like venture capitalists or private equity groups) that are typically selling to other investor-based shareholders.
A discount interest rate – typically around 15%-25% – is applied to account for the ‘time value of money', whereby cash becomes more valuable over time due to its income-generating potential.
Based on long-term assumptions, this income-based approach is typically used by the largest companies with long, consistent trading histories such as banks, utility and energy companies.
How Can You Prepare for a Realistic Valuation?
You can maximise your business valuation and sale price by improving the business beforehand. To do this, you need to be strategic throughout your business journey – from the start, to marketing your business for sale and negotiating a deal.
Here are a few tips on how to prepare for a realistic valuation.
Valuing your business is not only about its net worth. While this is an important factor, long-term strategic planning is vital. Make sure that your business plan considers details like your present and future goals, what improvements you would like to make and any other information you think a potential buyer would want to know. This will illustrate your business's potential.
Negotiation skills - confidence is key
Getting an accurate valuation will arm you with useful knowledge when it is time to negotiate the sale of your business. Understanding the details of your business's intrinsic worth will boost confidence in your negotiation skills, which will likely lead to a better sale.
Demonstrate to potential investors and buyers that the quantitative data underpinning your valuation is realistic. It will help provide concrete evidence that the business is worth investing in, and that their skillset and experience will generate a solid return on their investment and even take the business to new heights.
Seek professional advice
The valuation process can be challenging, so seeking professional advice will be helpful. If you take this route, make sure that the person you enlist has appropriate knowledge and expertise of businesses like yours. This will include your business's size and sector.
While there are similarities that run through all valuation processes, each sector will have different circumstances. To illustrate the valuation process in practice, here are some examples of calculating a business valuation.
How to value a petrol station
Petrol station values are typically appraised using one of three valuation methods.
The income-based approach, which best suits petrol stations with a long trading history of reliable earnings growth, is calculated by dividing a one-year cash flow projection by the market capitalisation (or market cap) rate.
The market-based technique, meanwhile, arrives at a valuation based on the going rate for similar private businesses and comparable share values.
Finally, discounted cash flow, based on the current value of free cash flow available over the life of the business, can be credibly used by both long established, low growth businesses and high growth, market entrants.
How to value a retail business
You may have a small, one-person operation or a large retail space with several employees. Regardless of your context, you will need to have clear, detailed records of your business in the years leading up to your valuation. Ensure you have records of your percentage of sales, the value of real estate or lease duration, fixtures and stocks.
You should also compare your business to similar retail businesses to see how it fairs with them. Comparing your business to others will give you a holistic understanding of the fair market value.
How to value a professional service firm
Professional service firms, broadly defined as knowledge-based businesses such as legal, consultancy, and accountancy firms, are light on tangible assets and vulnerable to changing circumstances that weaken their intangible assets.
As such, valuations are often based on projected earnings generated from historic trading performance, stellar reputation, intellectual property, products and services.
Much value also lies in the personal relationships between owner and clients.
Value Your Business using our Quick Valuation Tool
It’s clear that calculating the value of a business can be stressful and complex, and we want to make challenging processes simple to alleviate the prevalent stresses of owning, buying and selling a business.
With our quick valuation tool, you can estimate the worth of your company in under five minutes. If you’d like a step-by-step guide on how to use our quick valuation tool, you can read this helpful article.
We also have a more nuanced business valuation calculator that provides an accurate valuation of your business. If you’re confident that you have several business and financial details on hand, you can use ValueRight. If you cannot afford an accountant or valuation agent, ValueRight can give you a pragmatic, trustworthy valuation and you can proceed to advertise your business at a price that is fair and attractive to potential buyers.
To get all the benefits of this tool, ensure you provide as much information as possible when you begin the valuation. Inputting all your information into ValueRight will take you around 45 minutes and all your information will be stored securely.
Before you start your valuation, remember to have access to at least a year's profit and loss statements. If you can, three years of statements will offer a more concise picture of your business’s worth.
Do You Need an Accountant to Value a Business?
You don’t necessarily need an accountant to value a business. It is possible to do it on your own, but some business owners and buyers do prefer the expertise, support and guidance of professionals. It is vital that you find and expert who has the right industry experience and credentials.
Although accountants can value a business, valuation agents can do the same. They can appear in various sectors like business brokers, lawyers, and chartered surveyors. You can use our valuation tools before approaching a professional. Being informed about your business’s worth will give you leverage when hiring a professional and eliminate any uncertainty during the valuation process.
Business Valuation Advice from BusinessesForSale.com
It’s clear that the valuation process can be demanding, but concise planning, preparation and research will make it far easier. To conclude this guide, here are a few business valuation tips to consider:
Plan your exit strategy
Always plan for your exit. Develop a business plan that details what your business looks like, and how it can grow. A strong plan will maximise appeal, and it will show potential buyers that you are serious about the process.
Preparation is crucial
You can get a better valuation and selling price if you improve parts of your business that need attention. There are many ways you can do this:
- Increase your brand's reputation and goodwill.
- Look at ways you can reduce operating costs and boost sales.
- Improve staff training procedures.
- Upgrade software.
- Organise your paperwork, administrative tasks and record keeping.
Improving how your business functions is an important part of preparation.
Get the best possible advertising exposure
Valuing a business is one step towards selling it successfully. The next step you will need to take is to advertise it on a platform that will give you the best possible exposure.
Adverts should prominently flag features that will appeal to buyers:
- A high footfall trading location
- Low rent or an easily transferable lease
- A long track record of healthy, growing profits
- Unique and patented products
- Availability of seller financing or owner willingness to stay on post-sale
BusinessesForSale.com will continue to support buyers and sellers from across the world. Our site experiences high buyer traffic and has over 61,000 businesses for sale. Advertising your business with us will offer you great exposure, quality leads and a dedicated customer success team.
If you’d like more information on how we can support your business valuation, or you would like to connect with someone from the team, feel free to contact us.