How do you value a business?
Your business is probably your largest asset, so it’s understandable that you would want to find out what you could get for it, were you to sell up. There’s more to valuing a business than straightforward maths, but to get a sense of what your business could be worth, there are three different methods you can use. These are explained below.
How to value your business
From a technical angle, there are people in the financial sector who operate as business valuation professionals who can tell you what your business is worth in principle. However, there is a subjective angle to this too, as every buyer is in a different position.
Two different potential buyers can look at the same set of company accounts and financial details and come to two different conclusions. This will result in two different offers – and your business is only worth what someone is prepared to pay for it.
Read on for the technical side of business valuation – the most widely used valuation techniques – but don’t forget that there are always businesses that will fall outside of these parameters.
Assets-based business valuation
This is a straightforward assets minus debts calculation.
Take, for example, a construction company. They own cranes and heavy plant and other assets that have value. Estimating the resale value of this equipment and then subtracting any liabilities will give you a basic valuation. This method will generally result in a low figure as it ignores “Good Will”.
Good Will is the difference between the market value of your company and the value of your net assets (assets minus liabilities). Most companies have some Good Will, so using one of the following methods will usually give a higher valuation.
Discounted cash flow business valuation
This method involves a potential buyer looking at what your future cash flow is likely to be and deciding on what it is worth to them today. Essentially, they’ll try to calculate how much profit you expect to make over the next x years. If your cash flow is stable and predictable, they may take into account more years in this calculation.
After estimating your profit for the foreseeable future, and estimating what your business is likely to be worth when they sell it down the line, the potential buyer will apply a “discount rate”. This takes into consideration the time value of money and depends on the acquirer’s cost of capital and the element of risk in your business.
The elements that drive the figures here are:
How much profit the business expects to make in the future
How reliable the estimates are
Business assets aren’t involved in this calculation, as they are needed to generate the profit in the first place.
So, if your business has substantial assets, for example a large property, but is making a loss, then the asset-based valuation is best. For a profitable services business with few assets, such as a successful accountancy firm, the discounted cash flow or comparables method would be better.
Comparables
The comparables method involves looking at the value of companies that have recently been sold or companies where the value is public. You can often find out the value of businesses in your own sector by keeping your ear to the ground at your annual industry conference.
Be careful to compare your business in a like for like way as looking at much bigger corporates is likely to lead to you overestimating the value of your business.
Ultimately you can’t control which method a potential buyer uses to value your company, but any of these methods will allow you to estimate the value yourself.
It’s important to use good business planning to ensure you grow your business in the right way for long-term growth and value rather than short-term profit.
If you’re interested in how your business measures up right now you can use one of our business tools to get your Value Builder Score. Simply answer a few questions here. It only takes around 13 minutes to complete and gives you a chance to find out where your business is in terms of value.