Summary
A list and discussion of the methods to evaluate a small business' worth.
Why should I have my business appraised?
Business Valuation Methods
Seeking an appraisal of your small business’ market worth is beneficial for a variety of reasons — regardless of whether or not you plan to sell your company 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.
This is important because entrepreneurs are often expected to balance a variety of tasks in addition to managing the enterprise. Often, small business owners are overseeing product development, marketing campaigns, and facilitating expansion deals. Juggling each of these roles is difficult and, oftentimes, is complicated by the possibility of securing a potential sale of your business.
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 that are performing well, which has included many pandemic-resistant businesses, like liquor stores, gas stations, auto shops, and e-commerce ventures.
When pursuing a potential sale, a business valuation will most definitely be helpful. Still, there are other reasons that seeking an appraisal to determine your small business worth would be beneficial.
- Seeking capital – If you desire external investments to help your business expand, you will likely benefit from an expert business valuation, like those offered by BAF | G. 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 the industry they exist within. Understanding such a landscape, however, is important to truly assess how well your company is faring. Qualified evaluations like those conducted by BAF | G will suggest what similar companies are selling for within your industry or area. This sort of insight can be extremely beneficial when determining which direction you may want to take your 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 BAF | G to estimate your business’ worth through an appraisal.
1. Price-To-Earnings Ratio (P/E)
The P/E ratio, or multiples of profit, is a method often used to evaluate the worth of small businesses with an established record of annual earnings.
Through this method, expert valuators use prior profits to inform forecasted return growth. 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 $1,500,000.
Although the calculations used to reach the valuation are straightforward, expert valuators like BAF | G can suggest the correct number for your P/E ratio. This is because the P/E ratio often varies from business to business. Startups, for example, often have high ratios because they are high-growth companies. More established companies, on the other hand, like auto shops or local insurance agencies experience less drastic growth and will likely have a lower P/E ratio.
Depending on your particular business and its growth projections, your P/E ratio could be anywhere between one and ten. For the most part, ratios tend to fall between:
- 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
2. Asset Valuation
This 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 items 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.
The valuation that this approach yields is likely a lot lower than the business’ true worth because it fails to consider expected revenue and earnings. Regardless, it is a great starting point for appraising a business, especially if you do not yet have profits or are looking to liquidate.
3. 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 BAF | G 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.
4. Market Approach
This approach 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 a 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.
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.
Reach out to BA F|G today to have a confidential conversation about your situation and our business appraisal services.