It’s important to know the value of your business, no matter where you are in the business lifecycle. It’s even more critical if you’re looking to sell soon. Building a valuation of your business will help you understand your company’s total worth, making it easier to pitch to potential buyers.
What is a Business Valuation?
A business valuation is an assessment of the economic value of either part or all of your business. Used in several situations, business valuations analyze all aspects of the business to determine the sale value.
The analysis traditionally includes the company’s management, capital structure, future earnings, and market value of the business’s assets.
Why Should You Determine the Value of Your Business?
You should know the value of your business to help provide an accurate industry benchmark when determining how much to sell your business for. Business valuations also help you create your business’s strategic and growth plans.
Additionally, they highlight any areas in your business that may need attention before you grow your business or sell your business.
What to Expect
Business valuations can be thought of as the why, how, and who of your business. A business valuation will look at the why as the objective of the valuation. Is the valuation being done for a business sale, tax information, or partner separation? The why will help determine the purpose of determining the valuation results.
The how of the business valuation will determine the valuation method selected. As with the why. The how will produce different results based on the method used.
The who of a business valuation is what business or person will be performing the valuation. Look for people or organizations with experience with business valuations and ask what their philosophy is. Their philosophy will also determine the results of your valuation.
How is the Value of Your Business Determined?
The simple formula for determining your business’s value is – business value equals assets minus liabilities. Breaking this down, your business assets can include anything that has value and can be liquidated into cash if needed. Things like real estate, any necessary equipment to help run your business, and inventory your company has.
Liabilities are anything that costs your business. These things include your rent or commercial mortgage, bank loans, business debts, or any loans taken out for capital purchases. All businesses take on liabilities for operations and company growth. A business’s ability to pay debts reflects a lower risk than companies with more significant amounts of long-term debts. The better your company is at paying debts, the more valuable it is.
Most valuation methods look at your business’s financial history and future cash projections. These help potential buyers determine whether they are making a profitable investment. We’ll discuss the different types of business valuations below.
Approaches to a Successful Business Valuation
There are basically four different types of business valuations that you should know about. Each type uses various aspects of your company to determine the numerical value. One thing to note is your results should be because of consistent calculations, so be sure not to mix and match different methods and formulas. And don’t be afraid to call an expert if you need extra help.
Focusing on the amount of income a business is expected to make in the future, the income approach helps potential buyers understand how much your business would be worth compared to others. Most online business valuation calculators will use the income approach. You can take two types of valuation approaches under the Income Approach – the discounted cash flow method and the capitalization of earnings method.
- Discounted Cash Flow Method- The discounted cash flow method determines the current value of your business’s future cash flow. The cash flow is adjusted based on the risk involved in purchasing your business. This method is typically used in newer businesses with high growth potential but has yet to show a profit.
- Capitalization of Earnings Method- Like the discounted cash flow method, the capitalization of earnings method calculates a business’s future profitability by considering the cash flow, the annual rate of return, and its expected value. The difference is that the capitalization of earnings method assumes that the business’s value during a single period will continue. Establishing stable profitability for that business.
The asset-driven approach is another business valuation method, but it is based solely on the business’s assets. The Adjusted Net Asset Method calculates the difference between a business’s assets and the business’s liabilities. Both of which are adjusted to their fair market value. The asset valuation can also be used internally to help you keep track of your spending and capital resources.
To use the asset-driven approach, you’ll need to list your assets and assign a monetary value to them. An asset-driven approach is an excellent approach if your company holds a lot of investments or real estate.
The market approach to valuing a business is based on what other companies in the same niche have recently sold for. The benefit of using this approach is that you have a quick, high-level view estimate of the value of what you can sell your business for. However, because this method doesn’t use your assets, cash flow, or revenue to determine the value of your business, you may have a more difficult time selling your business in the future.
Common Mistakes When Valuing a Business
One of the biggest mistakes made by potential buyers and business owners is confusing the price of a business with the valuation. The pricing of your business is based on the valuation and the market demand for your business. The valuation solely determines the value of your business. However, both are used when potential buyers are making their investment decisions.
Improving Your Business Valuation
If your business valuation doesn’t meet your expectations, there are a few things you can do to improve the value of your business.
- Diversify your revenue streams.
- Establish some recurring revenue streams.
- Cultivate high-quality talent.
- Build up your business’s cash flow position.
- Increase your business’s profitability.
- Improve your bookkeeping.
- Streamline operations.
- Review your real estate and make improvements if needed.
- Update your marketing collateral, including your website.
- Build up your sales and marketing processes and procedures.
- Pay off your debt.
Remember, your business’s value is ever-changing, and potential buyers have their own ideas on how to value a business. Building your company’s value takes time, patience, and careful planning.
Understanding the value of your business before you sell will help you determine if there are things you should do to improve the value of your business. Working with organizations like Tsetserra Growth Partners can help you put the processes and procedures in place to build your business’s value. Our team has the tools to help your business grow.
Here is a little more about Our Process.