A Guide on How to Value a Business

A Company Valuation Guide for What a Business Is Worth

Business Valuation or Business Appraisal Steps and Cost

I. Overview: Determine the Value of Your Business

Your business is potentially your greatest asset, and it is essential to have a reliable assessment of its worth. The only problem is that business valuation is a dynamic discipline that includes various terms and variables. How much is my company worth? What is the best strategy for a business valuation? What are the factors that drive the company’s value? How can you maximize the value of your business?

How to Calculate a Business Valuation

This whitepaper aims to give you fundamental insights into the most common business valuation approaches. You’ll also learn how to value a business, starting with the standard structure of a business valuation. You should have a basic understanding and all the tools to perform an elementary business valuation and know your business’s worth or total market capitalization.

IRS & Tax Valuations

Valuing your business for the Internal Revenue Service (IRS)? We can also help as we have done many company valuations for tax reporting.

You can also read our article on what is a business valuation and how it is used to compute company value. As your business valuator, we know you need to know what your business is worth, your business’s value, not your book value.

II. Valuation of Your Business Introduction

Placing a value on your company is a complicated process. It needs the right mix of science and expertise. Company valuation is an art, not a science. Quote too low a figure, and you will undersell your company; aim too high and never sell.

Determining fair value for a company is never an easy process. To the owner, the method of valuation is personal and emotional. Often, they have an unrealistic idea of how much their company is worth. To the buyer, the valuation process is far more objective. Also, is this a financial or strategic buyer? Both will look at “fair market value” differently. Finding balance can prove to be extremely difficult in the business valuation process.

A Certified Business Valuation

A certified business valuation by an accredited Business Appraisal FL|GA|HI team member takes strategic and in-depth analysis to determine an accurate estimation of a company’s worth. We use numerous considerations in setting a sale price and deciding whether an investor’s bid is fair. It takes more than just a number of numbers to value a business. However, the most important thing that can influence the valuation of a business is how much the purchaser can spend. 

With that in mind, this article will try to answer a business owner’s question: “How much is my company worth?” and walk you through the business valuation process to determine the value of a business.

III. Business Valuation Methods

A Business Valuation is not an empirical science. Valuing a company is more of an art, and there are various approaches to measuring the worth of any business. Each of these approaches is based on varying financial facts and expectations that may result in a different valuation. For example, one way is based on the anticipation of potential cash flows. While the other is based on the value of a company’s assets.

Whichever approach one may use, you can prepare a statement of profits and profit/loss. This is because most clients request this document to determine the cost of products, sales, and operating expenses. 

Discounted Cash Flow Analysis

From the buyer’s point of view, this is the most reliable way to value a business. It allows the owner of the business to pay more attention to information such as sales and profit trends and the company’s capitalized value. This valuation method represents the amount of capital expected by the investor to reach the market in the next few years. With the basis of these cash flow estimates, the purchaser will determine their return on investment.

There are three critical questions one needs to answer to capitalize on future earnings:

1. Value: How much is the business worth today based on what it will earn in the future?
2. The Rate of Return: What is the investor’s expected rate of return?
3. Equity Share: How much equity will the investor get for their investment?

Once the investor has an estimate of the potential cash flow, we calculate the discount rate. Taken into account also is the time value of the assets. We determine this variable by the capital expense of the purchaser and how sensitive it is to the company or the market.  The discounted cash flow analysis is critical for larger companies and their investors, buyers, and sellers.

To make it smoother, remember that two important variables affect your company’s valuation in this method. These are the estimated profits to be made and how accurate such profit and cash flow forecasts are to generate the value of your business.

Small business owners want to know their market value, not book value. We can help you know the value of your most precious asset, your business, as your business valuator.

Please read the different methods used to value a small business so as a small business owner, you can know the value of your business, maybe your most valuable asset.

Assets-Based Valuation Approach

The most common way to value a company is to determine the value of its tangible and intangible assets. The assets usually purchased in a buy-sell process include merchandise, inventory, equipment, sales, office furniture (hard assets) and intellectual properties, brands (soft assets), and goodwill.

One of the most critical assets that you need to consider and evaluate in the buy-sell process is goodwill. From an accounting point of view, goodwill is the difference between your business’s market value and the worth of your hard assets.

Distressed Company Valuations

For distressed companies, since cash flows are negligible, the business appraiser determined liquidation value might be the highest number for lenders and stakeholders to compute the highest sale value.

However, goodwill can also refer to the value of the loyalty of your business’s customers. It includes a good name, a reputation for stellar products and customer service, experienced personnel, and a favorable location. Most companies have a collection of intangible assets in the form of patents, people, special procedures, intellectual properties, licenses, and brand recognition that add to their value.

Discounted Cash Flow

There are instances in which evaluating a business by asset appraisal is more efficient than the discounted cash flow method. For example, a money-losing restaurant that owns its own real estate (valued at $1 million) will benefit more from the asset-based valuation method. At the same time, a software company that estimates $3,000,000 in profit this year but has few assets will gain a more profitable valuation with the discounted cash flow technique.

A discounted cash flow (DCF) is a valuation method that estimates the attractiveness of an investment opportunity. DCF analysis uses future free cash flow projections and discounts them to arrive at a present value estimate. Which you can then use to evaluate the investment potential.

The Comparables Approach

Another way to value a company is to analyze the financial worth of comparable businesses that have sold in the recent past or market method. However, the issue with this method is that it often leads owners to make wrong assumptions.

For instance, a small accounting firm might believe that since Deloitte is trading for twelve times last year’s earnings, their company is worth at least twelve times last year’s profit. However, in most situations, the reality is entirely different. Size, depth of management, and not being driven by one or a few owners are just a few reasons why smaller companies’ multiples of earnings can be a third to one-half of those in the same industry but Fortune 1000 in size.

IV. A Framework for Business Valuation

Any business owner who wishes to sell his or her company will benefit from knowing the fundamental science behind valuation and the variables that influence the value of the company. A correct estimation of the valuation of your company will make a customer or an investor consider your business, while a bad appraisal could have an effect on their decision.

So, how do you value a small business?

Here’s an outline that might help you get an accurate answer to your question: “How much is my company worth?”

You can use an online business valuation calculator, but we haven’t found any that are reliable or any buyer/lender will take.

You can also read our articles on what to know about small business valuations and how to obtain a business valuation before selling your company.

Step One: Calculate the Seller’s Discretionary Cash Flow (SDCF)

The starting point of any business valuation, whether big or small, should be to determine the Seller’s Discretionary Cash Flow analysis (SDCF) or the Total Owner’s Benefit.

Please read our article on seller’s discretionary earnings or SDE to understand how SDE can show your true business’s value. Small business owners need to know what their business is worth.

SDCF refers to the pre-tax earnings of the business before the owner’s salary, non-cash costs, charitable donations, leisure activities, business-related expenses, any personal charges, as well as one-time expenses like the settlement of a lawsuit.

The great thing about SDCF is that it gives business owners an idea of their company’s actual cash flow potential. Cash flow analysis is king when determining a business’s value.

How to determine SDCF:

• Begin with the pre-tax earnings of your business or net income
• Add non-operating costs and subtract non-operating earnings
• Add interest expenses and deduct interest income
• If necessary, add one-time charges, and subtract non-recurring revenue

Step Two: Determine the SDCF Multiplier

Most businesses are traded for between one and three times the SDCF. This value is known as the SDCF multiplier, and it depends on several factors, such as market trends, industry, company size, owner risk, the company’s assets, and so on.

However, the most significant variable influencing SDCF is owner risk – the dependence/independence of the business from the owner. If a company is highly attached to the owner, it can be difficult to transfer it to the new ownership. In such a scenario, it will affect the business’ value. Market trends are also crucial. For instance, suppose you are selling your company in a niche that is expected to decline in the future. Then you can expect the SDCF multiplier to be lower than average.

Step Three: Add Business Assets and Deduct Business Liabilities

At the end of the business valuation process, you need to consider the assets and liabilities that are not contained in the SDCF multiplier.

Most business owners include intangible assets, such as reputation, goodwill, or personnel, in their SDCF multiplier. Likewise, equipment, furniture, and fixtures are also accounted for. However, as some experts point out, some accessible databases don’t contain inventory in their SDCF multiplier. That said, it needs to be addressed separately by the business owners via a detailed balance sheet analysis.

Most business owners do not include other tangible assets, such as real estate or cash, in the SDCF multiplier.

In the end, the company valuation formula should look something like this:

Company Estimated Value = SDCF * Multiplier + Assets not contained in the SDCF multiplier – Business liabilities.

Do you have IP or intellectual property? We can value your IP to give you a total picture of the present value of a business.

V. Business Valuation Guide Conclusion

Business valuation is a dynamic procedure, and various businesses have their own ways of assessing the value of their companies. If you are unsure which valuation approach is right for you, a competent evaluator will help you set a sale price and decide whether an investor’s bid is realistic.

You can also read our guide to choosing a valuation company.

You can also read about an example business valuation scenario on how we value a business here and its future profits.

Business Appraisal FL|GA|HI can help you value your company. Whether you are pondering a prospective business transaction, launching into succession planning, or encountering financial distress, our team effectively assimilates the information, makes the tough calls, and renders a robust valuation to help clients reach their objectives.

We want you to understand the business valuation methods we use, your future cash flows, and how they pertain to your situation’s current fair market value and what your business is worth.

You can also find out the many benefits of getting a business valuation here to find the value of your business. Call us to find out the steps and the low cost to know the value of your business for your exit strategy planning.

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