Learning how to accurately estimate the value of your company is important whether you’re looking to sell your company or preparing for a new round of funding. As you may have guessed, assessing the value of your business involves a plethora of factors that include analyzing your business finances and looking at other similar businesses to determine current market value. However, it’s not as simple as it sounds.
But before we dive deeper, let’s go back to basics. What exactly is a business valuation?
What is business valuation?
Business valuation refers to the process of determining the economic value of a company through the use of valuation methods. It can be used to establish the fair value of a business while looking into the management of a business, projected future income, and current market value. Here are some of the reasons why companies might need a business valuation:
- Determine the value of your company for investors
- Determine the value of your company for buyers
- For legal and/or tax purposes
- To acquire additional funding
- To make informed decisions when business planning
What are the three commonly used methods of valuation?
According to The Balance, there are three main approaches used to establish and evaluate the value of a company. Check them out below:
- Asset-based approach – Also known as “cost approach,” the asset-based valuation method determines the value of a business based on its net assets. This type of business valuation method uses two main methods: going concern and liquidation. When performed using the going concern approach, the value of a business is calculated by simply subtracting a business’ liabilities with its net asset value. For instance, a company that has $100,000 in assets and $46,000 in liabilities has an asset-based book value of $54,000. On the other hand, a liquidation asset-based approach means companies only determine their net cash once all assets are sold and liabilities are paid off. The main difference between the two main methods of asset-based business valuation is that liquidation takes various factors (such as machinery and equipment wear and tear) into consideration rather than just looking at book value.
- Earning value approach – Earnings approach is another popular business valuation method where a business’ actual value is identified by its ability to make money in the future. There are several different methods of valuation under the earnings approach, but capitalizing past earnings is the most commonly used. Capitalizing past earnings is a method that calculates a business’ anticipated profits based on current earnings and projected future income. Most use the earnings approach when they have a concrete understanding of the business and a robust bookkeeping process. Capitalization is computed using the following formula:
Capitalization Rate = Net Operating Income/Current Market Value
- Market value approach – When using the market value approach, the value of a business is found by comparing it to similar businesses that have been sold. The market value approach comes in handy when you are trying to set an asking price for a business purchase or when you are trying to justify the value of your business. As opposed to the other valuation approaches, the market value approach heavily depends on the number of similar businesses that you can compare your business to rather than quantitative data.
Why is business valuation important?
Business valuation is a great way to track a company’s performance in terms of economic value. If performed regularly, valuations can help chart the course of your business’s future by giving you an in-depth overview of your current financial standing. Not only can it be used to assess the fair value of a business for strategic financial planning, but it can also serve as a baseline for exit strategies.
Which business valuation method is best?
Like most business strategies and techniques, the best business valuation for your company depends on what you are trying to achieve. While the earning value approach seems like the best valuation method on paper, many businesses find the most success when combining this method with other approaches. For instance, when combined with the market value approach, an earnings value approach can increase the value of your company especially if you are performing well above industry standards.
What is the most important aspect of business valuation?
When it comes to business valuation, two of the most important aspects to keep in mind are income and market value. These two factors can heavily impact the value of your business regardless of the type of business valuation method you employ.
However, if you’re conducting a business valuation for the purpose of selling your company, remember that the final value of your company is determined by how much a buyer is willing to pay and the value that you are willing to accept. It can be a tough pill to swallow, but the final price can always be negotiated.
What is an example of a small business valuation?
As mentioned above, the worth of your business depends on how much a buyer offers and the figure that you are willing to accept. To get an idea about how much your business is worth, here’s a step by step guide on the earnings approach:
- Calculate your SDE. SDE stands for seller’s discretionary earnings, a metric used to determine a business’ historical cash flow. In simpler terms, SDE refers to a company’s profits before interest, taxes, depreciation, non-recurring expenses, non-operating income and expenses, and other adjustments – giving you a better understanding of your business’ true earnings. A buyer, or a third-party appraiser conducting the valuation, will use SDE as a benchmark to measure how much a business brings in on an annual basis.
- Determine your industry multiplier. As the name implies, the industry multiplier helps businesses assess their worth by finding the multiple of earnings that similar businesses were sold. For instance, if a company has an SDE of $100,000 and was sold for $200,000, then your multiplier should be 2x your SDE. Industry multipliers are important so that companies can be valued appropriately based on their growth potential.
While this seems like an oversimplified valuation process, it’s a great jumping-off point for businesses that are curious about determining their company’s value. As with all things in business, the best valuation method depends on the type of business as well as the purpose of the valuation. Make sure to do your own research or meet with a consultant if you don’t have the time to do it yourself. After all, you’re dealing with a process that needs a lot of time and effort for accurate results.
Wrapping Up: Why would you need a business valuation?
The truth is that there are a variety of reasons why you might need a business valuation. Whether it be applying for additional funding or planning an exit strategy, a business valuation will help you keep track of your company’s performance over time. Taking an in-depth look into your business from time to time helps you identify opportunities for growth and tighten aspects of your business that need to be improved.
About Kickfurther: How can it help your business?
Kickfurther is a great alternative funding option for businesses that have exhausted other efforts to secure additional funding. It is an online inventory financing platform that enables companies to access funds that they usually cannot acquire through traditional sources. Kickfurther applies a unique approach by allowing supporters and fans to purchase a company’s inventory on consignment.
The great thing about Kickfurther is that companies go through an extensive vetting process before they can tap into the Kickfurther community. This creative funding model is an innovative way for businesses to get the funding that they need without tying up their cash flow on inventory.
