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How to value your business

Just because you know your business inside out doesn't mean you can evaluate its worth correctly.

It's likely that your business is your most valuable asset, so it's only natural to want to know how much its worth.

But, just because you know your business inside out doesn't mean you can evaluate its worth correctly. Business valuation is a somewhat subjective science. 

Set the value too high and you may deter potential buyers, set it too low and you won't reap fair reward for all those years of toil and inspiration.

Engaging the services of a business-valuation expert - ideally one with experience of valuing businesses in your sector - is a must.

There are many different ways to evaluate the worth of a business, and a broker or corporate financier will be able to choose the most appropriate method for your business and circumstances.

The simplest means of evaluation is to examine the business's profits. This may not tell the full story, though.

An unusually good or bad year, perhaps because of a one-off large contract or unforeseen one-off cost, as well as the effects of the owner's exit strategy, can cause a temporary dip or rise in profits.

For a more accurate, representative appraisal, this examination should go back several years. Similarly, cash flow - ie the movement of money into and out of the business - can fluctuate and may not provide a reliable guide to value on its own.

"Assets include not only physical goods like vehicles, buildings and equipment, but intangible, subjective assets such as goodwill, brand and the skills and specialist knowledge of the employees"

Asset valuation

Adding up the worth of a business's assets looks, on the face of it, a pretty straightforward method of evaluation. However, assets include not only physical goods like vehicles, buildings and equipment, but intangible, subjective assets such as goodwill, brand and the skills and specialist knowledge of the employees.

Multiple of earnings

Also known as the price to earnings or P/E ratio, multiple of earnings is the most common form of valuation. The business is valued according to a ratio of the annual post-tax profit, generally between five and 10 times the annual post-tax profit, depending on the sector.

Technology businesses, for example, usually have a greater capacity than all other sectors to grow rapidly in a brief period of time. They are therefore valued according to a higher multiple than a newsagent, the scope for growth of which is negligible.

Entry cost

Entry cost values a firm according to the price of setting up an equivalent business from scratch and through comparison with similar businesses that have been sold in the same industry.

So the valuer calculates the approximate total cost of buying premises, training staff, buying stock, developing products and services, building brand through marketing and establishing a customer base.

A very transparent, easy to understand process. However, a business is often more than the sum of its parts and the entry-cost method takes no account of growth potential.

Discounted cashflow

Discounted cashflow, which derives value from projected cashflow over a set number of years, is ideal for a company which has invested heavily but has few assets and little financial history. Little surprise then that this is such a popular form of valuation among internet businesses.

The net present value (NPV) - the sum of future cash flows - is discounted to account for the 'time value of money' (the principle that the acquirer should be compensated for the delay in realising their cash) and a risk premium to insure against a scenario where projected cash flows prove to be overoptimistic.

Industry valuations

Some industries have their own unique, rule-of-thumb valuations based on the particular characteristics of businesses in that sector. Professional valuator Andre Pontoni has described rule-of-thumb valuations as "an average of prices from a number of transactions converted to a multiple linked to a common element found in all companies in a particular industry."

Whichever method is used, several further factors will influence the company's value. These include the circumstances of the sale, the age of the company, with older, well-established businesses commanding higher prices, and the general state of the market.

There is always an element of guesswork involved and it's entirely possible for two professionals to arrive at two very different valuations. If you disagree with one assessment, try asking for a second opinion from another professional.

Ultimately, a business is only worth what interested parties are willing to pay. So if you're desperate to sell but you haven't found a willing buyer for six months or a year, then you might wish to consider lowering the price.

Ready to sell? You are just 10 minutes away from advertising your business to millions of prospective buyers. Sell your business today.



Matt Skinner

About the author

Matt previously managed content across all titles in the Dynamis stable, including BusinessesForSale.com, FranchiseSales.com and PropertySales.com.

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