If you’re thinking about selling a business, you’re going to want to make sure you get a proper business valuation to determine its true value.
This can also be useful if you want to raise capital, sell just a portion of a business, or borrow money to expand operations.
Here’s a look at some common ways to value your business if you’re looking to sell.
How to calculate the value of a company
There are a variety of ways to calculate the value of a business, all with their own advantages and disadvantages.
The calculations can range from relatively straightforward to incredibly complex depending on your business size and industry.
5 Ways to Calculate the Value of a Company
- Worth of the assets
One simple way to value your company is to use an assets-based approach. Add up the value of your assets, minus the value of your liabilities and you’ll get the value of your company.
This is usually called the book value.
There are two ways to use this method.
The first is to use a going concern approach where your assumption is that the business will remain up and running.
The second is to use a liquidation approach where you base the value on what you’d get if you bought it and sold off all the assets. Also understanding the worth of the assets is essential for shareholders and directors alike when considering the members voluntary liquidation in Scotland, as it directly impacts the financial outcome for all parties involved.
One of the major downsides of this approach to valuing your business is that a profitable business is worth much more than its equipment, real estate, and inventory.
This method fails to account for future revenue and growth.
- Market capitalization
One of the simplest methods for valuing a publicly traded company is to use market capitalization by multiplying the total number of shares by the current share prices.
One of the drawbacks of this method is that it ignores debt and instead looks only at equity to determine value.
Another downside of this equation is that stock price is based on the perceived value of a company. The price may be high because of the anticipated success of a soon to be released product, for example.
If you’re a small business owner, this method is also unhelpful because your company is not publicly listed on any stock exchange.
- Discounted Cash Flow Variation
Discounted Cash Flow (DCF) is a much more practical method for valuing a company because it gives a better view of a company’s worth based on future revenue.
It’s a complicated formula that bases value on future cash flows expressed in today’s dollars.
It is often considered the gold standard for determining a business’s value.
However, the major limitation of the DCF method is that it relies on estimates, not actual figures. The accuracy of the valuation is dependent on how accurate your estimates are.
- Multiply the revenue
This is a method of valuation that uses a multiple of current revenues to determine the maximum value of a business.
The multiple will vary from industry to industry depending on a sector’s growth potential. It can also be affected by local economic factors. One industry might routinely use a 2X multiple whereas another might commonly use 1.5X, for example.
This is an easy calculation; however, it is not always a reliable indicator of value because revenue isn’t the same as profit, nor does an increase in revenue necessarily mean an increase in profit.
When valuing a small business, sometimes an owner will calculate a “floor” which is the value of assets only and a “ceiling” that represents the maximum they could expect to get for the business. Then they find a multiple between the two.
Sometimes called operating earnings, EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) seeks to go beyond merely looking at profit or revenue alone.
It attempts to account for the effect of taxes (which vary from region to region) as well as subtracting debt payments.
It also accounts for the effect of depreciation and amortization when calculating a company’s value.
Bring in a professional
If you’re thinking about selling your small business, calculating an appropriate value is a crucial step in the process. You want to get the number right because you want to get the maximum value out of the sale.
If you set the price too high, you’ll likely scare away potential buyers or spend a lot of time haggling and negotiating.
If you set it too low, you might scare off buyers who might wonder why the business is for sale at such a discount.
Acquire a Business and hiring a professional valuator might be worth the upfront costs.
It can be an expensive process so you should obtain an estimate and agree on a timeline to complete the report.
Choosing the valuation method
All the valuation methods discussed above have their various pros and cons so consider carefully before choosing one method over the other.
A purely assets-based calculation ignores future cash flows. A discounted cash flow analysis uses a variety of estimates, not actual figures. Determining a revenue multiplier can be a lot more of an art than a science.
Don’t discount your own intuition as well. Valuing a business is a lot more than mere number crunching. Consider business synergies when setting a value before you sell your small business.
Get the maximum value out of selling your business by completing a thorough business valuation using one of the methods described above.