A list and discussion of the methods to evaluate a small business' worth from a small business appraisal company, How to value a small business.
How to Value a Small Business
Why should I have my small business appraised?
Table of contents
- How to Value a Small Business
- Why should I have my small business appraised?
- Business Valuation Methods
- The Importance of a Small Business Appraisal
- What about an online business valuation calculator?
- Reasons for a Business Valuation
- Know the True Value of Your Small Business
- Price-To-Earnings Ratio (P/E)
- Small Business Valuation Calculation Methods
- Startup Business Valuations
- Asset Valuation
- Entry Cost Valuation
- Market Approach
- Different Business Appraisal Methods Conclusion
Business Valuation Methods
Seeking an appraisal of your small business market worth is beneficial for a variety of reasons. This is regardless of whether or not you plan to sell your company to potential buyers or transfer it to family. Knowing the true value of a small business helps ensure that you, as a business owner, have the confidence needed to make the most appropriate decision for your company and business portfolio.
You can also read what is a business valuation for small business owners.
The Importance of a Small Business Appraisal
This is important because it is an expectation from entrepreneurs to balance various tasks and manage the enterprise. Often, small business owners oversee product development, marketing campaigns, and facilitating expansion deals. Juggling each of these roles is difficult. And oftentimes, the possibility of securing a potential sale of your business complicates it.
Following the pandemic uncertainty that first impacted the market in 2020, small businesses are now selling at record prices. This suggests that buyers are willing to pay premium prices for businesses performing well. This includes many pandemic-resistant businesses, like liquor stores, gas stations, auto shops, and e-commerce ventures. In our business appraisal of your business, we will also show how the current interest rate affects your value and what a buyer will pay for SBA business loans.
When pursuing a potential sale, a business valuation will most definitely be helpful. Still, there are other reasons why seeking an appraisal to determine your small business worth would be beneficial.
What about an online business valuation calculator?
In most ways, you get what you pay for, and a free online or under $100 online business valuation calculator are a fun toy. But this fun toy does not give you a number that a buyer will take seriously or a bank will loan money against. Unlike home sales, the comparables must be researched, and home sales don’t have a business model, market share, net income, income statement, or balance sheet.
Justify the purchase price of your business with an SBA-certified business valuation to show a defendable business’s value.
A business broker might use one of the online appraisal calculators to determine your company’s value before going to market. An investment banker will spend the money on a business valuation with market research to justify the selling price.
Please read our article on what is my business worth for the small business owner to understand your business’s value. When it is time to sell your business, a business valuation will lead to a smoother selling process and a defendable asking price.
Reasons for a Business Valuation
- Seeking capital – If you desire external investments to help your business expand, you will benefit from an expert business valuation, like those offered by BA FL|GA|HI. This is because potential investors will want to understand the accurate value of your business before pledging any funds toward your venture.
- Expanding your venture internally – When making improvements in their business plans, owners often assume which areas need the greatest assistance. This is a poor way to go about improving your business. An annual appraisal can help you identify which areas within your business need the most improvement. Targeted assessments like these will ensure that you devote your efforts and resources most effectively when expanding.
- Understand how competitors are faring – small businesses may fail to consider the full landscape of their existing industry. Understanding such a landscape, however, is important to truly assess how well your company is faring. Qualified evaluations like those conducted by BA FL|GA|HI will suggest what similar companies are selling for within your industry or area. This insight can be extremely beneficial when determining which direction you want to take your business.
Know the True Value of Your Small Business
Regardless of the reason for pursuing a business valuation, knowing the true value of a small business will help ensure that you, as a business owner, have the confidence needed to make the most appropriate decision for your company and business portfolio.
Here are a few of the methods used by experts like BA FL|GA|HI to estimate your business’ value and worth through a business appraisal to produce a fair market value or business value through the business valuation process and the valuation methods and ways used.
Price-To-Earnings Ratio (P/E)
The price-to-earnings method or P/E ratio, or earnings multiples of EBITDA profit, is a method often used to evaluate small businesses’ worth with an established annual record from a business appraiser.
Expert valuators use this method to inform forecasted return growth through prior profits. A higher P/E ratio would be used for companies with high forecasted return growth or repeat earnings. For example, if the P/E ratio of three is used for a company that makes $500,000 in post-tax earnings, then the enterprise would be valued at a $1,500,000 market value.
For All Small Business Valuation Methods, please gather the following for the valuation process:
- Balance Sheet
- Income Statement showing net profit
- Tax Returns showing taxable income
- Cash flow forecast
- Seller Discretionary Earnings (SDE) like health insurance and other perks
- Accounts payable aging
- Accounts receivable aging
- Customer base makeup and market growth forecast
- Equipment list, list of assets, and any needed capital expenditures
- Any real estate holdings
- Depreciation tables
- Extraordinary or one-time business expenses
- All debt, loans, and business liabilities
- Stockholder’s agreements
- Trademarks and intellectual property (IP)
- Any pertinent tangible and intangible assets
Small Business Valuation Calculation Methods
Although the calculations used to reach the valuation are straightforward, expert valuators like BA FL|GA|HI can suggest the correct number for your P/E ratio. This is because the P/E ratio often varies from business to business. This is a critical determination to value your business when using the income approach or multiple of earnings.
We will also do a cash flow analysis of your business since you can spend cash flow but not profits. You will hear the term seller’s discretionary earnings (SDE) as this is the cash flow you or a new owner will enjoy that the business generates. The bottom line is a believable cash flow statement matters to your buyer and their lender.
Your growth rate is important, too, because we will apply a discount rate to your future cash flows to show the net present value. We will also compare your small business sales growth rate to your competitors as part of the market comparison. Your growth rate drives your discounted cash flow.
Startup Business Valuations
Startups, for example, often have high ratios because they are high-growth companies. On the other hand, more established companies like auto shops or local insurance agencies experience less drastic growth and will have a lower P/E ratio.
Depending on your business and its growth projections, your P/E ratio could be anywhere between one and ten. Ratios tend to fall between these numbers to value a business:
- 1-2.5 for small businesses
- 2-7 for enterprises earning up to $500,000 annually
- 3-10 for small firms with profits exceeding $1,000,000 annually
This method, the net asset method, although imperfect, determines the value of a business by taking the difference between the company’s total assets and total liabilities. To begin, make a list of everything the business owns. This may include physical items like machinery, property, and raw materials, in addition to intangible assets like intellectual property. Next, assign a monetary value to each asset. Sum up each of the assets’ values before subtracting any debts or liabilities from this number. This is also the liquidation value of your business, which is typically the lowest number and not used in the valuation process.
The valuation that this asset approach yields is a lot lower than the business’ true worth. Why? Because it fails to consider expected revenue and earnings. Regardless, the adjusted net asset method is a great starting point for appraising a business, especially if you do not yet have profits or are looking to liquidate for book value.
Entry Cost Valuation
Individuals who launch a venture from scratch often seek to understand what it would cost. The entry cost appraisal is beneficial because it can suggest what the value of a potential small business could be.
With this method, expert qualifiers like BA FL|GA|HI consider all startup costs, tangible assets, marketing fees, training, and more. Understanding what costs may be involved in your enterprise before incurring such costs is extremely effective as it will help you determine which areas of your firm you may be able to save on. For example, you may realize that you can source from cheaper suppliers or rent in a more affordable part of town, which increases the business’s value.
This approach, the market value, determines the value of a business by considering the market prices of similar assets or businesses that have been recently sold or are in the process of selling. It also considers the value of your business based on geographical location and area. It is especially helpful if you are interested in determining what particular asset, or business, should be purchased or sold for within your local market.
Publicly available data regarding company comparables and transactions are usually utilized for this method. Adjustments should be made for different quantities, qualities, or sizes when comparing assets.
Many small businesses are valued based on their discounted cash flow method or the discounted cash flow/present value of the future cash flow stream. That is why it is critical to evaluate all the different cash flows that make up the seller’s discretionary earnings in your company when we determine the value.
A small business owner’s discounted cash flow analysis is critical as you can only spend cash flow, not profits. Cash flow drives what a business is worth and whether your business sticks out versus a buyer’s other investment opportunities.
Different Business Appraisal Methods Conclusion
Small businesses go through a variety of financing stages. Regardless of how your particular business is faring, you should consider obtaining a business valuation to determine your firm’s true worth. We also have a guide on how to value a business, understanding you may need the business sales proceeds to fully fund your retirement. Small business valuations can be critical to your golden years.
Reach out to BA FL|GA|HI today to have a confidential conversation about your situation and our business appraisal services with a certified business appraiser. When valuing your business, your business is worth more than just the sum of its business assets.
Small business owners turn to BA F|G to value their largest asset, their business. Please contact us today so we can value your small business with a fast and easy-to-understand small business valuation report.