Let’s say you’re a business owner and want to know what your business is worth. We’ll walk you through the valuation process so you’ll know what to look for, how much to pay attention to, and how to set an asking price that won’t get you laughed out of the room.
Business valuation answers the question:
How much is your business worth?
Probably a lot. But you might not know the exact worth and that’s okay. There are several situations where valuing your business becomes imperative like when you’re planning to sell, before a merger, or looking to strike a partnership deal. Whatever the case may be, knowing how much your business is worth will help you make informed decisions about the future of your company.
Unfortunately, business valuation isn’t as simple as looking at its assets and liabilities – and for the inexperienced, it’s most definitely not as easy as plugging numbers into an online calculator and seeing what pops up!
So what do you do?
If you want to successfully determine the value of your business, follow the steps below:
Step 1: Prepare for Business Valuation
If you are going to do a business valuation, you should prepare beforehand.
Be like Abraham Lincoln – he said:
“Give me six hours to chop down a tree and I will spend the first four sharpening the axe”
To do a business valuation, be sure to gather all of the relevant documents, files, and financial information relating to your company as they will make it easier for you to determine the value of your business and make sure that nothing gets lost in translation during the process.
Also, use this step to understand that determining the value of a business is not always clear-cut because many factors contribute to what it’s worth.
For example, a proper veterinary clinic valuation will ensure you get the most accurate value for your practice by determining how much money your practice generates each year, the type of clients you have, the specialty of the practice, and the like.
Other factors that can affect value include size, location, the current condition of the business, how much money could be made, what other similar businesses are in the same location, and whether or not there are any other related businesses available for sale at the same time, etc.
Finally, know this: the more information you have, the better your valuation should be. At best, valuations are based on assumptions. The more accurate your assumptions are, the more accurate your valuations will be.
Step 2: Choose A Business Valuation Method
There are several different ways to value a business, each may have its advantages and disadvantages depending on what information you have available. Three popular methods used are:
Asset-based Valuation Approach
The most common method is asset-based valuation, which involves identifying all the company’s assets and then estimating their worth. This method can be used for both small businesses and large ones but it’s usually more appropriate for smaller companies because they tend to have fewer assets than larger ones and therefore, less complexity when it comes to valuing them.
A fair warning! If you don’t have the skills required for asset and liability valuation, this approach may cost you a lot of money and time.
If your company has been around for a while, you may want to consider using an income approach for valuation purposes. This method involves projecting how much cash flow your business will generate over a specific period and then using that figure as the base for determining how much it would be worth if sold today.
You can use this approach regardless of whether you are looking at buying or selling a company but it can be tricky if you don’t have detailed financial records or projections available.
Note: It’s widely considered by appraisers that the income approach in evaluating a business is the most accurate.
There are two basic ways to implement the income (or the earning value) approach.
Capitalizing past earnings: Valuation is determined by a formula that takes into account the earnings of a business and a capitalization rate (a value considered to be reasonable ROI).
Discounted future earnings: This method involves the average of forecasted cash flow by the capitalization rate.
Market-based Business Valuation Approach
The market-based valuation approach is probably the easiest one to understand – it involves comparing similar businesses being sold in your area or industry.
The primary drawback to this method is that it relies on the accuracy of the information gathered. This can be difficult because buyers or sellers may not be completely honest in divulging data regarding their transactions.
Step 3: Reach A Conclusion On Business Value
Once you’ve used the above approach methods to find an estimate of a business’s worth, the next step is to reach a final value on what it’s worth. This may be a bit tricky since each of these approaches may have different figures.
Here’s how business appraisers (and what you can do too) pull this together:
Assign a weighting value to each method to determine a fair estimate of the business’ worth.
|Valuation Approach||Estimated value of Business ($)*||Assigned Weight (%)*||Weighted Value of Business ($)*|
|Business value (summation of the weighted value) =||1,750,175|
Curious as to how to arrive at a percentage-weighted value?
The truth is the rules are not set in stone. It all depends on the business and its current state.
If you’ve read the entire article up to this point, you should have a good idea of how to do a business valuation.