Summary
Here is a guide to valuing your business or valuing a business you are thinking about buying.
A Company Valuation Guide for What a Business Is Worth
How Do You Determine the Enterprise Value of a Small Business?
A business valuation determines your current fair market value, not book value.
Business Valuation or Business Appraisal Steps and Cost
Know the Enterprise Value of Your Business
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 with 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 small business?
Retirement planning can be complex for a small business owner if their most significant asset is their business. Knowing your business’s value is an essential first step to retirement security. Knowing your business’s value or total market capitalization is critical when considering an asking price or dealing with an unsolicited offer.
How to Calculate a Business Valuation
This business valuation 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 understand all the tools to perform an elementary business valuation and know your business’s worth or total market capitalization.
IRS & Tax Business Valuations
Valuing your business for the Internal Revenue Service (IRS)? We can also help, as we have done many company valuations for tax reporting. The IRS wants to present your business’s enterprise value in a specific format and to certain standards.
You can also read our article on 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—not your book value but its market capitalization.
II. Valuation of Your Business Introduction
Placing a value on your company is a complicated process that requires 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 at your asking price.
Determining a company’s fair value is never easy. 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 requires strategic and in-depth analysis to determine an accurate estimation of a company’s worth. We use numerous considerations to set a sale price and decide whether an investor’s bid is fair. Valuing a business takes more than just various numbers.
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 based on your adjusted net profits.
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 approach is based on varying financial facts and expectations that may result in a different valuation. For example, one way to determine business value is to anticipate potential cash flows using current interest rates. The other business value determination is based on the small business’s current value of a company’s assets or asset valuation.
Whatever approach you use to generate business valuations, you start with a balance sheet and a statement of profits and profit/loss. 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, the discounted cash flow DCF method is the most reliable way to value a business. It allows the business owner to pay more attention to information such as sales and profit trends and the company’s capitalized value. This valuation method represents the capital investors expect to reach the market in the next few years. Based on these future cash flow cash estimates, the purchaser will determine their return on investment using the discounted cash flow method.
Current and projected future interest rates can affect the present value of future cash flows. See our article on projections in a business valuation when deciding an EBITDA multiple.
Three critical questions one needs to answer to capitalize on future earnings
- Value: How much is the business worth today based on what it will earn in the future?
- The Rate of Return: What is the investor’s expected rate of return?
- Equity Share: How much equity will the investor get for their investment?
BA FL|GA|HI calculates the discount rate once the investor estimates the potential cash flow. We also consider the time value of the assets. We determine this variable based on the purchaser’s capital expense and sensitivity to the company or the market. The discounted cash flow analysis is critical for larger companies and their investors, buyers, and sellers when determining the value of their business.
Earnings before interest, taxes, depreciation, amortization, or EBITDA (not net profit) are critical to sophisticated buyers versus a business broker and seller discretionary earnings or owner’s benefits via a cheap business valuation calculator.
Please read what is value in a business valuation to learn more about the business valuation process.
2 Important Business valuation variables
To make it smoother, remember that two critical variables affect your company’s valuation using this method. These are the estimated profits to be made and how accurate such profit and cash flow forecasts are in generating the value of your business or a company.
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 that you, as a small business owner, can know the value of your business, your most valuable asset.
Assets-Based Business 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
Since cash flows are negligible for distressed companies, the business appraiser determined liquidation value might be the highest number for lenders and stakeholders to compute the highest sale value. This is the realm of turnaround consultants and distressed investment bankers versus a business broker.
When determining liquidation value, a deep dive into the balance sheet is needed to assess all asset classes’ true value and orderly liquidation asset value. An asset sale is often the best approach for distressed or failing companies. The target company’s business plan or turnaround plan can also show value to distressed purchasers.
However, goodwill can also refer to the value of your business’s customers’ loyalty. 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, contributing to the evaluation of business worth.
Discounted Cash Flow
Sometimes, evaluating a business by asset appraisal is more efficient than the discounted cash flow method, especially when considering business evaluations. For example, a money-losing restaurant with its 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.
Future growth drives your future value, and your future discounted cash flows give you the present value of your predictions. Your ability to have believable financial statements and forecast your future annual sales revenue. Venture capitalists use this method and also care about the quality of your company’s management.
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. After looking at EBITDA, or earnings before interest, taxes, depreciation, and amortization, you can use it to evaluate the investment potential and a company’s value.
The interest rate environment can also significantly affect your cap rate and the subsequent value of your company.
Read a good article on how cash flow is a fact while net income is just an opinion when looking at a market multiple and a specific business valuation method when creating a market-based valuation.
The Comparable Approach
Another way to value a company is to analyze the financial worth of comparable businesses that have sold recently or to use the market method. However, this method often leads owners to make wrong assumptions.
For example, a small accounting firm may think that because Deloitte is trading at a multiple of twelve times last year’s earnings, their own company is worth at least twelve times last year’s profit. However, this is often not the case. Factors such as company size, management depth, and not being controlled by one or a few owners contribute to smaller companies having earnings multiples that are only a third to one-half of those in the same industry but with Fortune 1000 size.
Does an earnings multiplier have to be taken with a grain of salt? What earnings are you comparing when looking at a per-share price within the value of your business? A tax return and a solid cash flow statement have more value than an internal income statement for all business buyers.
You can read our article on the rule of thumb in business valuations, which is especially applicable when you value a small business for a business acquisition.
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 its value. A correct estimation of your company’s valuation will make a customer or investor consider your business, while a bad appraisal could influence 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 or a business broker, but we haven’t found any that are reliable or that buyers/lenders will take as trustworthy. All do a poor job of discounted cash flow analysis to determine a business’s value. A ballpark estimate from a business broker is not enough for such a valuable asset as your company.
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. Market conditions, market share, government risk, business loans, and other variables will be considered to reach your bottom line number.
Step One: Calculate the Seller’s Discretionary Cash Flow (SDCF)
To value a business, analyze the Seller’s Discretionary Cash Flow (SDCF) or the Total Owner’s Benefit. A business valuation is a deep dive into the economic engine of a business.
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 business’s pre-tax earnings before the owner’s salary, non-cash costs, charitable donations, leisure activities, business-related expenses, any personal charges, and 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 key when determining a business’s value.
How to determine SDCF:
- Begin with the pre-tax earnings of your business or net income/net profit
- 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 small 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, business expenses that are personal perks, and so on.
However, the most significant variable influencing SDCF is owner risk—the dependence/independence of the business from the owner. Transferring it to the new ownership can be difficult if a company is highly attached to the owner. Such a scenario will affect the business’s value. Market trends are also crucial. For instance, suppose you are selling your company in a niche expected to decline. Then, you can expect the SDCF multiplier to be lower than average.
A good business intermediary can guide you through the transfer of goodwill process with our help.
Step Three: Add Business Assets and Deduct Business Liabilities
Consider assets and liabilities not included in the SDCF multiplier at the end of the valuation process.
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 is the business valuation formula.
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. What if you are a startup company or a new business? We can provide you with a startup valuation and a pre-money versus post-money business valuation for your angel investors.
We can use several startup valuation methods to find your correct value. Please read our article on start-up valuations to understand the enterprise valuation process.
V. Business Valuation Guide Conclusion
Business valuation is a dynamic process, and different companies have different methods of assessing their value. This guide is a good primer if you want to know the basic guidelines and processes for business valuation. If you’re unsure which approach is best, an evaluator can help set a sale price and assess an investor’s bid.
You can also read our guide to choosing a valuation company when it comes time to value a company.
You can also read about an example business valuation scenario on how we value a business here and its future profits. We understand the value of your business is critical for your entrepreneurial success. We take our job as your source for business appraisals very seriously, and that is why many certified public accountants send us their business appraisals business.
Why BA FL|GA|HI for Your Business Valuation Needs
Business Appraisal FL|GA|HI can help you value your company. Whether considering a business transaction, planning for succession, or facing financial issues, our team efficiently analyzes information, makes decisive decisions, and provides a solid valuation to help clients achieve their goals.
We want you to understand our business valuation methods, future business growth and industry trends, and cash flows and how they relate to your situation’s current fair market value and your business’s worth. Your certified business appraiser will ensure you understand your final business valuation report and a company’s value.
Discover the benefits of a business valuation with BA FL|GA|HI. Contact us to learn the steps and low cost for your exit strategy planning and how to value a small business.