Business valuation is a process that assesses your business’s economic value. Different aspects are analysed in the valuation process, including the financial status, management structure, sustainability, and business assets’ market value. The uniqueness of your business can also be a value determinant.
Importance of business valuation
The emotional attachment, effort, and time you have given in making your business a success can make it very hard to assess its worth objectively. This, in turn, makes it essential to calculate the business value. The calculation is best handed to an independent third-party professional so that the results are genuine, not in favour of one side only, or driven by emotions.
Business valuation is usually done when the owner wants to sell. You will be surprised by the business’s potential opportunities and liabilities, which you never knew existed. The information gathered in the valuation process will make it easier for you to make good decisions; you might even consider adding more value to it before the sale to improve your returns.
Apart from selling, knowing the value of your business is also very important when looking for financing. The venture capitalists, lenders, and investment bankers will need to know how much the company is worth before they can grant you any funding.
The other scenario that will call for a valuation is if it’s a partnership and the other person wants out. Calculating the partner’s share value will help you buy them out or find an interested partner. The precise value smoothens the entire process.
A business owned by a couple will need a valuation in case of a divorce. Calculating the value is the only reliable way of dividing marital assets equitably.
The determination of the value of your business can get contentious. For instance, a partner could end up demanding higher stakes than what you think it is worth. For this reason, different methods are used to evaluate the business objectively.
Common valuation methods
Valuation by stock price – This valuation method is easy for publicly traded companies. The calculation is done using the number of traded shares and the current selling price in the stock market. Whereas this method of giving value to the business is easy, it is not the best because it is based on business value perception in the market. The findings may not reflect the company’s actual worth.
- Investors could base the prices on the anticipated success of new product launches, only for it to flat line and plummet the shares
- Investors may not do a serious business valuation and can anticipate growths in the future only for them not to happen
- There could be an assumption that because the business grew last year, it has the potential to grow within the next year, yet this is something that does not always happen
- Stock prices can ride on temporary news and do not reflect the underlying value
- The share price could be meaningless, especially for companies that are not heavily traded.
Valuation by comps – Another method you can use to get the value of your business is by comparing it with similar companies. The companies within your location and in the same industry can help you extrapolate the value of the business. You can acquire comps from the sale price of recently sold businesses. You can also use metrics like earning and price ratio. When using this method, however, it is essential to remember that sale data that is not recent will not reflect current value. The comps may also differ in areas like state of equipment or staff value, thus making it tricky to determine the correct value truly.
Assets valuation is a prevalent appraisal method and one of the most efficient in getting the correct business value. The math is not complicated as it only calls for adding assets value and subtracting the liabilities to reach total value. One approach under this valuation is going concern, which assumes the company will remain up and running without selling its significant assets. The other approach is liquidation which bases the value on what would be fetched if the business was to close and all assets sold and debts settled. The only drawback with this method of valuing a company is that good business are worth much more than just real estate, inventory, and equipment.
Valuation by discounted cash flow is more effective because it relies on actual cash flow numbers rather than an appraisal of assets. Ultimately, it is the cash owners; a good income with a negative cash flow will give you hardships.
Valuation by startup cost – It is not very popular but can be of value, especially for those buying or selling manufacturing firms. In such a situation, calculating equipment costs, vehicle purchase costs, space leasing costs, and trained workforce costs can give a measure of the business’s worth. The cash flow and future earning potentials are not considered in this method, which could be why it is not as popular.
Valuation by revenue multiplication – You can also determine your business value by looking at the revenue. You must multiply the current annual revenues by the given industry threshold figure to get the value. The time revenue approach is usually not used by itself analysts, and most use it to set upper limits on company value.
After calculating your business’s value, it will be time to think about the cash at hand and total company debt. The information is crucial in setting the final price, yet most people need to remember it. Buyers may only be interested in paying debts within specific amounts; on the other hand, you may want to raise your business price if you have more cash for immediate expenses. It is essential to come up with a way to deal with the surplus and debt when getting the value of your business.
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