When evaluating the worth of a business, there are three widely accepted methods for calculating business valuations:
- Asset Valuation Method: This approach determines the value of both tangible and intangible assets. It focuses on assessing the current market value of the business’s assets, without relying on factors such as turnover, profit, or goodwill.
- Discounted Cash Flow Analysis: This method gauges the present value of future opportunities or cash flows. It is suitable for businesses with a stable growth history, providing a basis for projecting future growth. However, it is sensitive to the forecasts and assumptions used in the valuation, making small adjustments capable of causing significant variations.
- Capitalisation of Profit: This is the most commonly used method, assuming the business is a going concern. It establishes the current value of the business based on adjusted earnings, essentially determining the goodwill of the business. Unlike discounted cash flow analysis, this method does not incorporate future growth into the valuation.
Different businesses may require different valuation methods. For instance:
- A machinery hire business heavily reliant on fixed assets may find the asset valuation method more applicable, valuing assets at their current market value without considering turnover, profit, or goodwill.
- Larger, more established businesses with a steady growth history may opt for discounted cash flow analysis, projecting future growth based on historical performance.
The Capitalisation of Profits method involves determining the value of the business in its current form. This is done by applying a business capitalisation rate or profit multiple to the adjusted profits (before interest and tax) over the most recent relevant years. Tangible assets net of applicable liabilities are then added to arrive at the total enterprise value. Dividing this value by shares or units on issue provides the share or unit value, respectively.
When assessing the value of your business, it’s crucial to consider the impact of unusual events, such as the recent COVID-19 pandemic or significant weather events. If your business has been significantly affected, adjustments to the profits may be necessary to reflect a ‘normalised’ position.
Business valuations serve various purposes, including:
- Sale of a business
- Transfer of shares/units for succession planning
- Meeting insurance requirements for shareholder agreements
- Addressing considerations in marriage settlements
- Monitoring the business to determine areas that could be improved that would increase business value
As a business owner, understanding your business’s current value and learning how to enhance it are essential for optimising its value when the time comes to transition or move on. To discuss your business valuation options in more detail please speak to your local Accru advisor.