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There’s an old saying in the UK that goes a little like this – ‘A company is only worth as much as someone is willing to pay for it.’ With that said, you can take many different approaches to ensure you get a fair sale price for it.
Valuing a company is beneficial for business owners and entrepreneurs trying to purchase or sell a business. A valuation of a business can help when securing investment, getting a better share price and more.
An annual valuation helps to secure funding and concentrate your attention on areas of progress to grow or expand your business.
In the end, you want to obtain a valuation that does not sell the company shortly. It should also not overstate what the organisation is really worth it.
If you find the valuation straightforward, you may need to rethink your system. It’s difficult to find a balance. Combining a couple of valuation methods is a smart idea.
What Affects Business Valuation?
Although certain aspects of an organisation can be easily valued – intangible assets will still exist.
It would help if you also looked at: beyond stock and fixed assets (such as land and machinery), which are tangible and have substantial value:
- The company’s credibility
- The reputation of the company’s clients
- The firm’s trademarks
- The factors underlying the assessment (like a forced sale rather than a voluntary one)
- The entrepreneurial age (think startups making a loss that has lots of future potentials, versus established profit-making companies)
- The power of the team behind the organisation
What Kind of Commodity Have You Got?
These intangible assets make an accurate valuation very difficult to obtain, but you can use a variety of methods to make it easier.
Business Valuation Methods
Price to earnings ratio (P/E)
Businesses are also valued by their ratio of prices to earnings (P/E) or multiples of profit. The P/E ratio is ideal for companies that have a proven profit track record.
It can be guided by profits to figure out an acceptable P/E ratio to use-if a company has strong forecast profit growth. It could recommend a higher P/E ratio. And if a firm has a strong record of repeat profits, it can also have a greater P/E ratio.
Using a P/E ratio of four for a corporation making £500,000 post-tax income, as an example, means it will be priced at £2,000,000.
Depending on the business, how you achieve the correct number for your P/E ratio will vary dramatically. Tech startups also have high P/E ratios, since they are typically businesses with high growth. Like an estate agent, a more popular high-street business may have a lower P/E ratio and is likely to be a mature company. In the financial portion of the reports, you can see quoted historic P/E ratios of firms.
And they are more appealing to investors as the shares of quoted firms are easier to buy and sell. Typically, smaller, unquoted businesses have around a 50% lower P/E ratio than their quoted counterparts.
There is not actually a ‘normal’ ratio that can be used to value all firms since P/E ratios vary wildly. Having said that, as a P/E ratio, a business advisor might recommend a valuation of four to 10.
Entry cost
This is an easy one-how much does it cost to set up a company equivalent to the one being valued?
You need to take into account all that has taken the organisation to where it is today. Make a note of all the expenses of starting up, then of the real assets. How much does it cost to create any goods, build a client base, and hire and train employees?
After that, when setting up, consider the savings you might achieve. Subtract that from the calculation if you can save by putting the company somewhere else or using cheaper materials.
You’ve got your entry cost and a valuation when you’ve considered everything.
Valuing the assets of a business
Stable, proven companies with a large number of tangible assets are also appropriate for evaluating these assets. In property and manufacturing, good examples of companies like this are such.
You need to start figuring out the company’s Net Book Value (NBV) to perform an asset valuation. These are the assets reported in the accounts of the business.
You should, then, think about the economic reality surrounding the properties. In essence, this implies changing the percentages according to what the properties are actually worth.
Old inventory, for example, depreciates in value. Knock those off if there are loans that aren’t likely to be paid. And the value of the property may have increased, so refine those figures also.
Discounted cash flow
This is a difficult way to value a business, depending on assumptions about its future. The approach is ideal for mature companies with stable, predictable cash flows-think of utility businesses.
By predicting what potential cash flow will be worth today, discounted cash flow operates. By adding the dividends expected for the next 15 or so years, plus a residual value at the end of the era, you can achieve a valuation.
You use a discount rate to measure today’s value of each potential cash flow, which accounts for the money’s risk and time value. The time value of money is based on the premise that, due to its earning potential, a quid today is worth more than a quid tomorrow.
The discount interest rate will usually be anywhere from 15 to 25%.
Industry rules of thumb
In specific industries, purchasing and selling companies may be more popular, so those industries may have some rules of thumb that you can use as a guide. They’re going to focus themselves on things other than profit.
Let’s look at retail- rules suggest that companies are valued on variables such as market turnover, how many clients they have, and their number of outlets.
Based on how they plan to shake things up and bring operations to industry standard, it is a good way for a buyer to value the business.
A Business Valuation Based On Immeasurables
A company is often only worth what someone is willing to pay for it, which takes us back to our opening paragraph. Intangible assets listed earlier could be taken into account here, with negotiating capacity also playing a role.
It could be more beneficial to a buyer if the company has desirable relationships with clients or suppliers.
A good management team (that won’t jump ship) might also add value unless the buyer doesn’t have a stable team behind them to move the company forward.
And each prospective buyer may see different risks, reducing the value variably. As a business owner, the key is to pre-empt and mitigate any risk.
How Much is My Business Worth?
As we mentioned earlier, it can help you concentrate on areas for improvement by valuing a business. To help ensure a good valuation, there are many things you can do, including:
Planning ahead: have a strong strategic plan, concentrating on how both short-term and long-term outcomes can be achieved.
Risk reduction: For example, consider diversifying if you depend on a small group of customers.
Putting great policies in place: think about how you store data, whether it’s financial information or just how the company runs. Often, the more you can demonstrate, the greater the faith in the business.
What works for one company won’t necessarily work for another company. However, we hope you’re closer to coming up with a range of figures by providing an overview of some common business valuation methods.
We hope you found this article useful and hope it helps you with valuing your business and selling it for what you’d like to get for it. If you could use some more useful business articles, then head over to our blog or post your questions directly to our forum.
