As a business owner, you may find yourself wondering “how much is my business worth?” This is a valid question, as the value of your business can have a big impact on your ability to sell it, raise capital or even just get a loan.
Fortunately, there are a number of methods you can use to value your business. In this article, we’ll explain everything you need to know about valuing a business in 2023, including the strategies and best practices of doing so.
But First, What is Business Valuation?
Business valuation is the process of determining a business or company’s economic value.
This can be done for a variety of reasons, such as:
– To help set priorities during the strategic planning process
– To identify opportunities and optimize decision-making
– To track business progress and measure performance
– To support marketing and investment decisions
-To plan to sell your business
Who Does Business Valuation?
Some business owners conduct valuation on their own, while others hire professionals to get specific insights. Depending on the purpose of the valuation, different experts may be consulted.
For example, if you’re looking to value your business for the purpose of selling it, you may want to hire a certified business appraiser. If you’re simply trying to get a general idea of your business’s value, on the other hand, you can likely do the valuation yourself or consult with a business valuation calculator.
Taking the Time to Learn Business Valuation: Is It Really Worth It?
Short answer – yes! Whether you’re planning on selling your entire business, part of it to venture capitalists or just want a general idea of how much it’s worth, understanding business valuation is crucial to making informed decisions.
Not to mention, if you ever find yourself in a business dispute, being able to prove the value of your company can be invaluable (no pun intended).
How to Value a Business
Business valuation can actually be done in a number of ways. Three of the most popular include the Multiple Analysis, Discounted Cash Flow and Asset/Liquidation models, each of which consider different factors when looking for an answer. We’ll detail these methods and explain how they work below.
Multiple analysis is the most common way of valuing small businesses, mainly for the reason that it’s simple and (generally) accurate. It involves calculating total worth based on the ratio of one or more metrics to the values of direct competitors.
This starts with figuring out what metric is most important for the particular company you’re valuing. Usually, this is sales, earnings or assets, but it could be something else entirely depending on the business.
Then, you need to find comparable companies in order to generate a multiple. The most important part here is making sure that these companies are actually comparable to the one you’re valuing. This means they should be in the same industry, have a similar business model and operate in the same general market. A few examples of commonly used multiples include price-to-earnings (P/E), price-to-sales (P/S) and price-to-book (P/B).
Once you have your multiple, all you need to do is apply it to the target company’s metric. So, if you’re using the P/E multiple and the target company has earnings of $10 million, you would simply multiply $10 million by the P/E multiple to get a valuation.
Business Value = Business Metric x the Multiple
This approach is relatively straightforward, but it does have some limitations. The most important one is that it’s based on historical data, so it doesn’t account for future growth potential. This means it’s best suited for businesses that are already established and aren’t likely to experience major changes in the near future.
Discounted Cash Flow
Discounted Cash flow, sometimes abbreviated as DCF, is a valuation model that estimates a company’s worth through expected future cash flows. It’s all about considering potential as a main driver of value, rather than past performance like the multiple analysis.
Calculating DCF comes down to three main factors:
First and foremost, the time period must be determined. This is usually set at 5-10 years, as anything beyond that is generally too difficult to predict with any degree of accuracy.
Next, the discount rate must be decided upon. This is usually represented by a company’s Weighted Average Cost of Capital (WACC), which refers to the required rate of return investors expect from investing in the business.
Last but not least comes cash flow. This is all of the cash that’s expected to come in (revenue) minus any cash that needs to go out (expenses). Estimating cash flow can be difficult, which is why it’s important to use realistic and achievable numbers.
Once all three of these factors have been decided, the DCF formula can be applied as follows:
DCF= (CF/(1+r)^1) + (CF/(1+r)^2) + (CF/(1+r)^3) + … + (CF/(1+r)^n)
r = discount rate
n =time in years before future cash flow occurs
The DCF model is a great way to value companies with high growth potential, as it takes future earnings into account. However, it can be difficult to estimate cash flow, which is why it’s not always the most accurate method.
The asset/liquidation value is exactly what it sounds like: the value of a company’s assets minus any debts or liabilities. This is a fairly straightforward way to value a company, but it only works if the company in question is profitable.
To calculate this, you simply need to look at the balance sheet of the target company and subtract any liabilities from the total value of assets. This will give you the net asset value of the company, which is also known as the liquidation value.
Asset Value – Liabilities = Liquidation Value
This method is often used to value companies that are struggling financially, as it provides a floor for the price. However, it doesn’t take future earnings potential into account, which means it’s not always the most accurate method.
Choosing the Right Valuation Method
Now that we’ve gone over some of the most common valuation methods, it’s time to talk about how to choose the right one. The method you choose will depend on a number of factors, including the type of business you’re valuing, the purpose of the valuation, and your own personal preferences.
For example, if you’re valuing a company that doesn’t have much in the way of physical assets, the Asset/Liquidation method probably won’t be the best choice. On the other hand, if you’re looking for a quick and easy valuation, the Multiple Analysis might be the way to go.
It’s important to keep in mind that there is no right or wrong method – it all depends on your specific situation and an experienced Business Broker will be able to help.
Tips to Make the Business Valuation Process Easier
While the business valuation process is extremely important, it isn’t inherently easy. Regardless of which calculation model you choose, there are a lot of documents to be reviewed, things to consider and numbers to be crunched in order to get an accurate number.
Here are a few tips to make the process a little easier:
The first step is to get organized. This means collecting all of the relevant financial documents, such as tax returns, balance sheets and income statements. Once you have everything in one place, it will be much easier to start the valuation process.
Know Your Numbers
The second step is to really know your numbers. What are the revenue and expenses for your business? What is the value of your assets? What are your liabilities? Knowing the answers to these questions will make it much easier to choose the right valuation method and get an accurate number.
Choose the Right Method
As we talked about earlier, choosing the right valuation method is crucial. Make sure to take into consideration the type of business you’re valuing, the purpose of the valuation and your own preferences. Choosing the wrong method can lead to an inaccurate valuation.
Work with a Professional
Finally, one of the best ways to ensure an accurate valuation is to work with a professional. Business appraisers have experience valuing businesses of all types and sizes, so they can help you choose the right method and get the most accurate number possible.
The Bottom Line
Business valuation is a complex process, but it’s important to take the time to learn the ins and outs. By understanding the different methods and knowing how to choose the right one, you’ll be able to get a much more accurate idea of your company’s worth and be better positioned to capitalize upon it in the future.