Unless in the not-for-profit sector, the success of a business is ultimately measured by its value.
Reasons for Conducting a Business Valuation
- Conducting due diligence
- Determining the price to buy, sell or merge a business
- An annual reality check of your business performance
- Adding new shareholders, setting prices for new stock purchases or buying back shares from existing shareholders
- Business owner personal net worth calculation for estate tax liability and planning, insurance or financial planning
- Obtaining and maintaining finance
- Divorce proceedings of shareholders
- Incentive and stock plans
- Mediation and arbitration of disputes (e.g. Between shareholders/business partners)
- Bankruptcy, liquidation or reorganizations
Key Factors Affecting the Value of Your Business
- Current, recent and projected profits and cash flow
- The level of cost and how effective the control mechanisms are
- Growth potential
- The value of assets such as property, equipment and stock-in-hand
- How full your order book is
- The strength of customer relationships
- The number of customers – is the business reliant on a few key customers
- The level of debt
- Experience and commitment of key staff
- Goodwill and intellectual property such as patents
A potential buyer will also consider how dependent the business is on the skills you perform, and the likely extent of your future involvement.
External factors should be taken into account. Although these can't be controlled, awareness of their impact on the value of the business needs to be a key consideration in the timing of your exit:
- The general economic situation
- Industry/market trends in your business sector
- How high similar businesses are being valued.
- The number of potential purchasers
METHODS OF VALUING A BUSINESS
Multiple of Earnings
Usually applied to businesses with a record of sustainable profits. Any unique or one-off assets are deducted for an estimation of “normalised” income. Smaller companies are often valued at a lower sum than larger businesses dealing in similar products.
Capitalisation of Future Cash Flows
Usually applied to mature, cash-generating businesses. Similar to the earnings multiple concept but based on cash flow. Future cash flows are estimated and discounted - this is known as discounted cash flow. Long-term cash flow is worth less than cash flow due shortly.
Asset valuation
Usually applied to a stable business with significant tangible assets. The starting point is the value of assets stated in the accounts - known as “net book value”. These figures are then refined to reflect factors like changes in the value of assets or bad debts.
Entry Cost
It may be possible to estimate the entry cost of creating a business similar to yours. This can then be used as a basis for valuation. Costs could include buying equipment, employing staff, developing products, setting up sales channels, marketing, and so on. If the cost of entry is low there's little likelihood of you achieving a successful sale.
Any amount of criteria can be applied to ascertain the value of a business. The true value of anything is the price someone is prepared to pay for it.
Based on information from
Business Link