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How to value a business

Many factors go into the process of valuing a business. In real terms, a business value is obviously whatever price someone is willing to pay for it – whether that’s more or less than you’d expect. But how do you know what price is reasonable? Before entering any negotiations, it makes sense to undertake some analysis and determine what your business is objectively worth.

This article will help you understand better how businesses are valued. You’ll learn what affects business valuation and a range of different methods that can be used to estimate value. Looking to work out what your own business is worth? You’ll find advice on how to do that too.

What affects business valuation?

If you’ve ever seen the sale of a well-known company covered in the news, you may have wondered ‘how do they arrive at that valuation’? The value of a business will be determined by a wide range of factors. Toggle through the carousel below to look at some of the most common factors. 

  • Engineer in hardhat is using a tablet computer in a heavy industry factory.
    Tangible assets

    The first thing you should do when you want to determine a business value is take stock of all tangible assets. Stock, land, and equipment have fixed values, so this is the easiest aspect of a business to price.

  • Full office
    Reputation

    Whilst this is a difficult one to quantify in value, reputation certainly has an impact. If the business has a bad reputation, it’s understandably less desirable. Its value drops accordingly.

  • Young woman pays via payment terminal and mobile phone.
    Customers

    A consistently loyal customer base guarantees a certain level of income, and this adds value to the company.

  • AAT branding
    Trademarks

    Does your business own any trademarks? If it does, this could be valuable property. Anything that increases your company’s profit-making potential should be taken into consideration when making a business valuation.

  • Empty Carnaby Street, London, UK
    Age

    The age of your company matters, but there’s no straightforward rule like “new = bad or old = good.” After all, a start-up could be extremely valuable if it has huge potential. An established company could also be very attractive to prospective buyers.

  • digital tablet with a graphic
    Revenue

    Anyone considering investing money in your business will look at revenue trends to assess its value and potential. If your business demonstrates ongoing growth, that heightens its appeal.

  • Unrecognizable businessman walking in an office.
    Workforce

    Does your management team depend on a dominant CEO? Businesses that have a talented management team are generally seen as more dependable than ones that rely on a single individual. This can affect the perceived business value.

  • Labelling parcels
    Product and service portfolio

    The kind of product or service that you offer is also important. Buyers will look for high gross margins because that’s a sign that your business possesses competitive advantages.

  • sales manager giving advice to his couple clients
    Context

    The context in which you’re selling your business matters. If the sale is voluntary, your business will be able to demand more money than it would if you were being forced to sell up.

Different business valuation methods

Many different methods can be used to value a business. Often, multiple methods are combined to form a more complete picture of a company’s worth. Here are some of the most common business valuation methods.

  • Price to earnings ratio
  • Entry cost
  • Valuing the business assets
  • Discounted cash flow

Let’s go into more detail on each valuation method below. 

Price to earnings ratio

This method of company valuation uses a ratio of price to earnings to determine the worth of a business. Using this method, the current share price of the business is related to its earnings per share.

This can be very useful for analysing how the value of a business has changed over time. It can also be used to compare a company’s earnings to those of a competitor.

The price to earnings ratio is often referred to as the price multiple. This is because it is used to find out how much investors pay per dollar of earnings. A higher ratio suggests that investors expect higher earnings growth in the future.

If someone is considering buying your business, they might use this ratio to determine whether your stock is under or overvalued. Because valuations and growth rates vary between industries, this ratio is not useful for comparing companies from different sectors.

Valuing the business assets

If your company is well established and owns many tangible assets, it’s fairly straightforward to assess its business value. You can work out the Net Book Value of your business by checking the company’s accounts and finding the overall worth of the assets you own.

Unfortunately, you can’t just leave it at that. For a realistic estimation of your company’s overall worth, you’ll have to adjust the value of each business asset to reflect economic reality.

The value of property fluctuates, so you’ll have to confirm what your assets are really worth. If stock is old, it has most likely lost real-world value, for example.

To value your business using this method, you need to adopt a pragmatic approach. Maybe you’re still due money from a while ago, but you’re unlikely to ever receive it. In that case, you should deduct it from the value of your business.

Discounted cash flow

Because this method of business valuation depends on predictions about your company’s potential, it’s best suited to companies that are already well established.

After a while, a company’s cash flow becomes more stable and predictable. This historical data can be used to make informed projections about its future.

This is one of the more complex methods of company valuation. What you have to do is calculate the profit of a company in today’s terms. To do this, you first need to establish a discount rate that takes into consideration both the risk involved and the “time value” of the money.

What does “time value” mean? It’s a concept explaining that a sum of money is worth more today than it will be in the future because today it has future earning potential.

What other factors can affect a business valuation?

Whilst the methods described above provide you with a framework for working out the value of a business, there are additional factors at play that make it difficult to ascribe a one-size-fits-all approach. Below are two of the main additional factors to consider – click on the dropdowns to reveal more.  

  • Industry rules of thumb

    Different industries have their own markers of success that determine their value. That’s why it’s difficult to make comparisons across industries. Comparing profit alone only provides one part of the overall picture.

    For example, a chain of restaurants could be valued highly if it has a great reputation, many branches, and a loyal customer base. It couldn’t be straightforwardly compared to a tech company.

    To value your business using industry rules of thumb, you first have to determine what constitutes value in your industry. Then, you can compare your business against other companies in your sector.

  • Intangible business assets

    Your business undoubtedly has tangible assets with an easily established worth. However, it will also have assets that are more complicated to ascribe value to. What is a great reputation worth in monetary terms? How do you attach a sum to a strong customer base?

    Much as beauty is in the eye of the beholder, value is often in the eye of the buyer! Each buyer will perceive different advantages and disadvantages as they evaluate your business.

    The good news is that someone who sees great potential in your company may be willing to pay more than you’d ever expect to receive for it.

How much is my business worth?

Figuring out the value of your business requires some nuance: it’s a science, but it’s also an art! In reality, no one method can provide a complete picture of your business’s worth.

Business value can’t be defined by profit margins alone. That’s why it makes sense to combine techniques for a more accurate estimation.

To find out what your business is worth, you might ask yourself the following questions:

  1. What tangible assets does my business own, and what are they worth in reality?
  2. What intangible assets does my business own, and how can I ascribe a monetary value to them?
  3. How does my company compare to others in my industry, and how is it performing against industry standards?
  4. Can I use my company’s past to make projections about its future growth, and what would that growth be worth in today’s money?
  5. How much would it cost to start up the same business today, and how much would I need to spend to get it to the level of success that my business currently enjoys?
  6. What is my business’s price to earnings ratio, and using this, is my stock under or overvalued?
  7. Has anyone offered me money for my business? If so, how much are they willing to pay for it?
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