How to Value A Business
If you own a business, you understand that many things, such as time, effort and resources (read money), go into building a successful firm. So, if several years into building your company, you decide to sell it or merge with another business to form one big firm, how do you quantify all these factors to know how much your venture is worth throughout its existence?
It can be challenging for most entrepreneurs to objectively asses the worth of their companies. However, valuing a firm shouldn’t be too hard. Depending on the type of firm, there are several methods to value a business.
In this article, we’ll discuss business valuation, its importance, the factors influencing it, and most importantly, how to value a business.
Let’s get started.
What is a business valuation?
Business valuation is the process of determining how much your company or business is worth. It is a multi-discipline skill that determines if you will sell, buy or reinvest in your business.
Undervaluing the business can lead to losses while overvaluing can result in losing the next investment funding, as seen in the Dragon’s den.
Let’s understand why business valuation plays a vital role in the business’s continuity.
Why value a business
Conducting a company valuation will help you know your company’s market value. Determining the value of a business is crucial if you’re considering to;
a. Buy or sell a business
A business’s worth is the total value of assets, including equipment and inventory, fewer liabilities. When you want to sell or buy a business, conducting a valuation can help you with several things, including;
- Deciding the right time to buy or sell your business
- Improving or bargaining its perceived value
- Closing a deal quickly, whether selling or buying
The company’s perceived value influences the willingness to buy or sell a business. It is crucial to conduct a valuation accurately to arrive at a sensible value and improve the chances of closing a deal.
b. Improve your management strategy
A business is judged by how it’s run. Valuing your business can help you make informed decisions that streamline your business processes. Some critical decisions to be made upon valuation include;
- Areas to be improved to deliver quality service and goods
- Measuring the performance of your management team. This can help in offering incentives or changing roles in your management team.
c. To secure investments
Successfully securing investment funding is vital for any business’s long-term sustainability. But going into the Dragon’s Den to secure financing for your company can be a making or breaking point, especially for small businesses.
It demands that you have your business’s projections at your fingertips, which should resonate with the company’s performance. Otherwise, you might flop. The good thing is that valuing your business can help you with exactly that!
Another way to internally secure investment funds is through buying and selling the company’s shares and issuing new share prices. All these factors significantly rely on the current valuation of the company.
What affects business valuations?
Some of the underlying factors that affect business valuation are;
1. The age of the company
The age of the company can showcase its stability. A more established company has a positive asset column hence a higher valuation.
On the other hand, a relatively new business may have a negative asset value because of the challenges affecting setting up a profitable company. This impacts the valuation negatively, though it has the possibility of breaking even in the future.
2. What is the circumstance of the valuation
Why you want to sell or buy a business can result in you under-buying or over-selling the firm. To leverage this to your advantage, consider if;
- It is a forced sell- This usually happens if the business owner is either old or sick and needs resources for retirement or treatment. In this circumstance, the company is generally undervalued as it can accept the first deal it gets.
- The seller is winding down the business- In this regard, you might want to consider the assets present less the liabilities to arrive at a reasonable valuation.
3. How tangible are the assets?
During valuation, the future profitability of assets such as machinery, lands, and properties is considered.
As for businesses that have intangible assets, you can use the below principles to come up with a sensible company valuation.
How to value a business
The principles used to value a company are many. The following are some ways to consider when you want to value a business;
a. Asset valuation
If a business has tangible assets such as buildings and land, it is crucial to factor them into your valuation. Industries involved in the manufacturing sector also fall into this asset class.
To know the value of such industries, determining the Net Book Value (NBV) from the accounts provides a clearer picture. It highlights all the assets registered to the company minus the liabilities. Remember to account for inflation, depreciation, appreciation, and collected debt when conducting asset valuation.
Also, intangible assets such as intellectual property, customer satisfaction, staff experience, and brand recognition can influence the value of your business.
b. Entry cost
This valuation model is arrived at by considering the number of resources it would require you to grow the company to where it is today. You must calculate the production costs from the start of the business to the delivery of goods or services to consumers.
To negotiate for a better deal, highlight factors that limit the business growth, such as the location of the company and alternative sources of raw materials. Such factors play a critical role in reaching a more agreeable valuation.
c. Price to Earnings ratio (PE)
Also known as multiples of profit, this valuation criterion is used for profitable businesses. The PE is arrived at by dividing the company’s stock price by its Earnings per Share (EPS).
A company with a high PE ratio may indicate that it is either;
- Overvalued
- Expecting high profitability growth in the future, or
- Has consistent earnings from sales
Such companies include hot-tech startups and quoted companies.
Always recalculate the accounts using your accounting policies to get a clear picture of the company’s profits.
d. Discounted cash flow
Discounted cash flow is a complex method of valuing a company. It is used for mature companies with continuous, predictable cash flow, such as utility companies.
Discounted cash flow works by predicting future cash flows today. The valuation is arrived at by cumulating the dividends of the forecasted ten or so years plus a residual value at the end of the forecasted years.
The risk and time value of money are calculated in today’s cash flow forecast using a discount rate of 15% to 25%. It is based on the fact that cash today is much more valuable than future cash.
e. How to use turnover for valuation
Turnover is based on the net sales made in a particular period. It shouldn’t be mistaken for profit. Instead, turnover showcases how well your company is doing and the urgency, convenience, and popularity of your products or services.
Turnover is used alongside gross and net profit to place a reasonable value on your business. It can offer a clear picture of the company and streamline your business’s operational costs to increase profits, thus fetching a higher value.
Wrapping up
Valuing a business can be a daunting experience; however, with the above criteria, you can arrive at a sensible valuation.
Depending on your business, you can try different valuation methods. I hope this blog has showcased the best way you can come up with the actual valuation price of your company.
