Business valuation: How to calculate your company’s worth

Wondering how much your business is worth? Even if you’re not interested in selling it anytime soon, it’s important to know the value so you can develop strategic plans for the future.

In a perfect scenario, you’ll be able to sell your business at a time when:

  1. You’re personally ready to sell
  2. The recent historical performance of the business has been strong, and
  3. The economy is doing well so you get the best possible sale price.

If you have time and plan accordingly, there are things you can do to increase the value of your business and get a better price. Of course, it’s best to work with a professional financial or business advisor to get a realistic value estimate for your business and to help a sale go as smoothly as possible. But first, the following steps will help.

First steps for evaluating the business’ value

To begin, examine the following:

  • The estimated market value of any equipment, inventory, and/or other assets that would be included as part of the sale
  • Your company’s financial data, including information on profit/loss, revenue, assets, wages, cash flow, etc.
  • Any non-arm’s length transactions which may or may or not be incurred by a purchaser (e.g., owner’s wages or related party rent)
  • The current market and likely future financial performance.

If you don’t have clear and accurate financial statements that include a breakdown of all assets and debts, now is the time to get everything sorted, even if you aren’t looking to sell your business in the near future.

What is meant by ‘goodwill’ value?

A vital component of any business valuation is that of ‘goodwill’. Business goodwill is an intangible asset and represents the portion of the calculated business value that cannot be attributed to the current market value of net business assets. Or simply, goodwill exists in a business when the valuation is higher than the business assets minus liabilities.

A well-run business is worth more than the sum of its parts. This value – over and above the net asset value – can be created from a number of factors, but most commonly is due to brand recognition, customer loyalty, favourable location, excellent management and even the quality of employees.

The most common business valuation methods

Once you have considered all of the points above, you can start to get a better idea of potential value (or selling price). There are many different methods of valuing a business. Some industries have specific, accepted approaches however the most common methods are based on:

  1. Discounted cash flows
  2. The capitalisation of maintainable earnings
  3. Net asset value

Discounted cash flows

The Discounted Cash Flow Method is generally most appropriate when future growth rates or margins are expected to vary significantly. This method is based on the theory that the value of a business is equal to the present value of its projected future benefits. The discounted cash flow calculation is complex, so it is vital there is considered, accurate information as small changes to inputs can result in large changes to calculated valuations. Because of this, these valuations are subject to significant scrutiny.

The capitalisation of maintainable earnings

Partly due to the complexity associated with the discounted cash flow method, the favoured valuation methodology of small to medium-sized business is often determined based on the capitalisation of maintainable earnings. The capitalisation of maintainable earnings is especially appropriate for mature businesses with relatively stable profit as the valuation methodology is centred around the notion of maintainable earnings.

Maintainable earnings are calculated based on the historical profit of the business over a period of time (commonly three years) but exclude non-business and extraordinary items. The business value is derived by capitalising the maintainable earnings by an appropriate multiple, which is reflective of the inherent risk the business may have. For instance, a high-risk business may attract a capitalisation rate of 50% (or a multiple to a maintainable profit of 2), whereas a low-risk business may attract a 20% capitalisation rate (or a multiple to a maintainable profit of 5).

Net asset value

An asset-based approach may be appropriate when valuing a capital-intensive company, or where losses are generated, causing the discounted cash flows and capitalisation of maintainable earnings methodologies to indicate a value lower than the adjusted net asset value.

Under the net asset value method, the assets and liabilities are adjusted from their book value (often cost) to their fair market value. Adjustments will also need to be made for any internally-developed assets that are subsequently not recorded on the balance sheet of the entity.

An experienced business advisor can assist you in assessing your business value accurately so that you don’t sell your company for less than what it’s really worth. If you’re looking for help from an experienced adviser in selling your business, contact the experts at Accru today.

About the Author
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Rhys Bithell
With a double degree in Corporate Finance and Accounting, Rhys’ love of numbers has been apparent for a long time. He understands the importance clients place on their money and helps them make the most of what they have. Rhys thrives on the big picture and tackles clients’ challenges head-on as if they were his own. He analyses businesses thoroughly and draws on his experience with a diverse range of industries in order to provide considered advice. Clients rely on Rhys during times of change. He undertakes the role of external CFO for several businesses and led Accru Harris Orchard’s largest sale of a client’s business. He appreciates that selling a business is often a once in a lifetime event and does everything in his power to maximise the outcome for his clients. Known for his approachable and affable nature, Rhys develops close relationships with his clients. He likes nothing more than knowing his clients are happy with their financial position, allowing them to enjoy the good things in life.
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