Business Valuation

Written by: BUSINESS

Business Valuation Guide For Newbies

If the time has come to sell your business, you are probably wondering how much it costs. Understanding the value of your business is the key to setting the right price, managing a smart marketing campaign, and leading negotiations with the potential buyer.

Some business owners choose to outsource valuation to professionals like business brokers. Others use online calculators and try to crunch numbers on their own. Either way, you need to have a good understanding of how much your business is worth. Otherwise, you risk losing money.

Let’s take a closer look at business valuation and how it works.

 1. Studying the Market  

When valuating your business, you can use different approaches. One of them is studying the market. It involves two aspects:

Comparison

You find companies similar to yours and analyze their value indicators. You need to study at least two such companies and then figure out the average business value indicator. Then you can apply these indicators to your company.

While you will not get an exact measurement of your company’s value, the approximation can be very close. Some company-specific factors may affect the value of businesses you study, giving you incorrect insight. That’s why it’s important to compare as many companies as possible.

Business Valuation Guide For Newbies

Adjustments

To find out what your company is worth, you need to take several similar businesses and analyze recent sales. Then you have to make adjustments based on the differences between your company and the companies you are studying.

One of the problems with this method is limited data. According to Orlando Business Broker, you may have a hard time finding out how much other business owners are asking. Sellers tend to keep this information confidential.

An easy way to get access to such data is to hire a business broker with experience selling similar businesses.

When you are comparing the price for several companies, you need to break it down into:

  •         Taxable assets
  •         Non-taxable assets
  •         Real property
  •         Personal property
  •         Tangible assets
  •         Intangible assets

Considering all the above factors, you could get a fair approximation of how much your business costs. However, you will not achieve a clear estimate.

Studying the market and comparing companies can give you a good start when valuating a business. The information you gather can help you make important decisions about how to proceed with the sale.

2. Classic Valuation

The classic approach to business valuation is based on income. However, it demands several important assumptions and requires detailed data. Interestingly enough, it helps you come up with figures that are more accurate than you get when studying the market and comparing businesses.

Classic valuation allows you to calculate the value using several scenarios, giving you a range of values to work with.

To calculate the value of your company, you assume that the current cash value of the business is equal to the present value of future cash flows that it will continue generating through the rest of its lifecycle.

To use the classic income valuation, you need to divide the net operating income by the rate of capitalization.

With an income approach, you can achieve a fair estimation of the company’s value. However, it has a few limitations. Unlike the comparison approach, it doesn’t allow you to separate figures by asset type. It also heavily depends on assumptions about the forecast period. Small changes in these assumptions can have a huge effect on the final figures.  

Overall, you have to make a variety of educated guesses, not all of which may be correct.

3. Replacement Cost Approach

Another way to valuate your business is to calculate the replacement cost of your company and adjust it for depreciation to get a replacement value. The value is likely to be much lower than the businesses’ book value because assets that aren’t used are deemed obsolete.

Overall, this approach allows you to come up with a solid capital valuation that’s supported by current market costs. You can also get a clear value for tangible assets.

The replacement cost approach works well with the classic valuation method. However, the amount of data you need to collect to calculate the replacement cost can be highly voluminous, thus making the method time-consuming.

Final Thoughts

Determining the value of your business can be a complicated task. If you aren’t sure that you can do it on your own, consider hiring a business broker. Remember, all calculations you make are approximate.

The value of your business can rise or drop dramatically within days if the economic situation or the market change. 

Last modified: September 14, 2021