Whatever side of the deal you’re on, valuing a business can be a tricky process, so it’s tough to know where to start with things. The amount of time and energy business owners put into their venture means it’s important to approach valuing the operation in the right manner.
Whatever the reasons for determining the worth of a business, help the process go as smoothly as possible with these helpful steps. We’ll be touching on the methods of evaluation, the factors that commonly affect the process and how it can improve areas of the business going forward.
Why should you value your business?
As well as buying or selling a business, some other common reasons for valuation include:
Methods of evaluation
If your business has a proven track record when it comes to profitability, then the price to earnings ratio method would be a suitable method. The technique involves three elements:
The end figure is your business’ price to earnings ratio.
This is the process of valuing the business based upon what it physically owns.
Businesses with large physical assets, such as land, buildings, machinery and inventory, are well suited to the asset valuation method. Conversely, businesses with intangible, non-physical assets, like brand recognition and intellectual property, would not be suited to this approach.
The accounts will show the net value of the business i.e. total assets minus total liabilities – though they may not factor in things such as inflation, appreciation or depreciation, so you’ll need to be sure that all asset values are up-to-date.
The asset valuation method tends to produce the lowest value for a business because it assumes that the business doesn’t have any goodwill, another intangible asset. In accounting, goodwill is defined as the difference between a company’s market value (what people are willing to pay) and the value of its net assets (assets minus liabilities).
How much would it cost to set up a similar business to the one being valued? That’s essentially what the entry cost approach entails. You’ll need to factor in all the elements that it took to set up the current business, from the cost of employees and developing products to building assets and creating a customer base.
Specific industries will have their own specific formula which you can use to value a business operating within that sector. This is a great way for a buyer to value the business based on how they’re expected to operate to industry standard.
These rules of thumb tend to be based on things other than profit. For example, retail businesses will be valued on factors such as business turnover, how many customers it has and its number of outlets.
Of course, there are valuable things about a business that can’t be tangibly measured. A business is truly worth what someone is willing to pay for it, so intangible assets have to be considered at times.
A business with a strong relationship with its customers or suppliers may be more valuable to a buyer, while a buyer that lacks a stable team might look at the prospective management and find them a suitable fit. Conversely, buyers can also see risks and the value lowers accordingly; as a business owner, it’s important to pre-empt and minimise potential red flags.
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Other factors that affect valuation:
There are many other additional variables that can affect the value of a business. As a baseline - brand reputation, competitors and the wider economy can play a part, but the following can have more of a major effect:
How much is your business worth?
If you’re looking to sell your business, or are keen for an accurate valuation – you’ll be keen to find the truest way to determine its worth.
There’s no one-size-fits-all approach to securing a good valuation, but there are lots of things you can do to improve your chances. Valuing a business can help you focus on areas for improvement later down the line when the time is right for you to sell.
Planning ahead by having a solid business plan, with a focus on the ways you’ll achieve both short-term and long-term results, can stand you in good stead. As we mentioned earlier, reducing risk can also help. Consider whether you rely on a particular group of customers, then diversifying into other areas can help you navigate choppy business waters if a particular customer or client stops doing business with you. The less dependent a business is on a big client, the higher your business valuation will be.
Additionally, strengthening the accounts and operations processes you have in place is well worth doing, too. Whether it’s financial records or how the business works, take into consideration how you store information. The transparency with which you can show figures and information to buyers may instil greater confidence in them.
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