You’ve worked hard building your business, so you want to know what its value is when it’s time for you to sell. Here are the basics.
What is business valuation?
Business Valuation is a process that determines a business’ worth. Four basic criteria that can affect the value of a business are circumstances of the sale, tangible business assets, intangible business assets and years of operation. The process requires attention to detail, planning and a disciplined effort by the business owner. A valuation can figure out the fair value of the business for a number of reasons, including sale value, adding a partner or other commercial reasons. Owners may also use it as an objective way to estimate a business’ value for internal purposes.
Information needed to value your business
To ensure you value your business properly, you will need to provide a large range of up-to-date business financial and non-financial information. If you require assistance to hire a professional or contact someone you know who has experience in this field. An interested buyer may ask if they can value your business independently and will need access to proper business documentation. The two main financial statements you will need for a business valuation are balance sheets and income statements. To value a small business properly, you should have these documents from the past 3-5 years available.
How to value a business
You worked hard building your business so, obviously, you want to know what its value is when it’s time for you to sell. There are several commonly used business valuation methods you can use to figure out your business’ value. Here are three main methods to tell you about: The ‘Asset Approach’ method focuses on a business’ net asset value or fair market value of its total assets minus its total liabilities to figure out how much it would cost to recreate the business. There is room for interpretation in this method in terms of deciding which assets and liabilities to include as well as how to measure how much each is worth. The ‘Income Approach’ determines the business’ value based on its ability to generate economic benefit for its owners. The economic benefit such as the net cash flow or seller’s discretionary cash flow multiplied, capitalised or discounted to perform this valuation. The ‘Market-Based Approach’ establishes the business’ value in comparison to past sales involving similar businesses. If done properly, these are accepted ways of determining the value of a business.
Earnings Before Interest Taxes Depreciation and Amortization (EBITDA) formula
The EBITDA formula can be used to analyse as well as compare profitability between companies and industries. It takes away the effects of accounting and financing decisions and can be used in valuation ratios and compared to enterprise value and revenue. Keep in mind EBITDA is a non-GAAP (Generally Accepted Accounting Principle) measure which allows for a larger amount of consideration when it comes to what is and what isn’t included in the calculation. It’s important to know that businesses often change what’s included in the EBITDA calculation from one reporting period to the next. You should also know that it’s a good way to evaluate a business’ profitability, but not seasonal cash flow.
Key business valuation concepts
When valuing a business, you will have to understand some key concepts. Just like any employee, owners who work in their business are also entitled to a salary for their work. The fair salary for owner concept is the amount of money you would be willing to pay a worker to do the same job, superannuation included. Another concept is a fair return on investment (ROI) and it refers to the return you are expecting in the current marketplace for a risky investment instead of just putting the money in the bank. This would be in direct proportion to the risks involved. Next is the fair return on net tangible assets concept which is the return you would expect from the net tangible assets of the business. And now the super profit concept, which is the amount you would be expecting to get from the business after deducting the fair salary for the owner and a fair return on tangible assets.
Business value synthesis
Due to the fact that no one valuation method will provide you with a definitive answer, you are able to use several results from various methods to figure out what you believe your business is worth. This is called business value synthesis. It’s important to know that using various methods may produce somewhat different results. So before reaching the business value conclusion these differences need to be worked out.
An independent valuation provides you with answers to the questions you often need to ask about the value of a business or property. For a professional, accurate valuation service, contact us today.