For a small business owner, your business is like your child: it is priceless. This mindset is good when it comes to running the business with optimism, but significantly less helpful when it comes to selling your business.
Business value is not cut-and-dry, it is complex and during sales, the end value of the business is the result of complex and lengthy negotiations. And although business valuation in the selling process is tumultuous, there are a few methods you can use to find a good estimate for your business’ worth. It is important to know that these tools used by professionals should not be used exclusively, a combination of them may provide the most accurate estimate of the value of your business.
Cash Flow Pattern Analysis
In this method of valuation, the business is valued using past cash flow patterns in an attempt to gauge cash flow in the future. When these predictions of cash flow are completed, an associated ‘discount rate’ is applied. This rate, calculated from an assessment of risk, is used to give a present-day value. Most reliable for business with stable cash flows, usage in other, more unsteady businesses could present an over/underestimate.
Goodwill worth and asset value
It is easy to put a value on the physical assets of a company: the worth of the delivery vans, stock, employees, and equipment. You can then subtract the debts and liabilities of the company to gain a net value of the physical aspect of a business. However, there are other assets that are difficult to assign a value to. These include simple things like market share, business repute and advertising, and employee knowledge; while they are simple, they cannot be directly measured.
“This goodwill element ensures that the net assets of a business are higher than just the physical assets.”
Because these invaluable assets cannot be valued the same way as other assets, a new category of worth is introduced: goodwill. This goodwill element ensures that the net assets of a business are higher than just the physical assets. This type of valuation is most suitable for failing or struggling businesses.
The most common method: earning multiples
Earning multiples look at the history of profitability of a business and apply a multiplier. This multiplier is derived from industry sector benchmarks and is generally taken from similar sales and mergers in the industry. The goal of this method is to evaluate the business based on its history as well as the general value of other businesses in the sector.
The most significant problem with nearly every valuation technique is that they rely on past success as a measure of future results. There is always the risk in this that the company will not continue to perform at the same level, or will become extremely successful even though they had a meagre history. The valuation game is complex, so reach out to a professional to make sure you are valuing your business at a fair and accurate price, so that you are getting the most out of your hard work.