How to Value A Business: The Key Methods Explained

May 2, 2019 How to Value A Business

Pretty much everyone who goes into business dreams of making their fortune. This might be through years of running a successful high profit enterprise, or it might be by selling the venture off for a tidy sum and disappearing into the sunset.

Whenever thoughts turn to the latter, one question inevitably occurs – how do you value a business? The answer is more complex and elusive than you might suppose because, ultimately, the value of any business is contingent on the careful and often lengthy negotiations that take place between parties when it is sold. There are many variables involved in determining the market value of a business, and the opposing objectives of the buying and selling parties inform their differing subjective valuations.

That does not mean, however, that business valuation is completely without methodology. On the contrary, specialists in the field forge careers applying a range of sophisticated calculations to the matter, all of which are aimed at supporting sales negotiations by providing some tangible and objective figures.

Next time you are curious about what your business might be worth, here is a simplified run down of some of the main considerations the professionals use.

Discounted cash flow

With this method, the valuer will look at cash flow patterns to try to forecast cash flow into the future. Once these predictions about future cash flows are made, a ‘discount rate’ is applied, based on an assessment of risk, to give a present day value. This method is more suitable for businesses with stable and predictable cash flows.

Earnings Multiples

Earnings multiplies rely on a benchmark for the relevant industry sector to extrapolate value from past profits and are the most common valuation method used. You could, for example, take an average of net profits over a specified period and apply the multiple to come up with a valuation. The rationale is to provide an indication of over what period a purchaser might get a return on their investment.

We can use comparisons of what businesses in the same sector have sold for recently, similar to the way guideline property prices are arrived at. The obvious drawback to this method is that there needs to be appropriate examples on which to base the comparisons. In a sector where there is not much takeover activity or deals have not been publicised, it doesn’t provide much help.

If the discounted cash flow method is vulnerable to the risk involved in forecasting future performance, valuations by earnings multiples have to be qualified by the fact that there is not always a direct correlation in business outcomes from past to future. It doesn’t, for example, take into account abnormal blips, both good and bad.

Assets and Goodwill

One of the more straightforward ways to calculate the value of a business is simply to value all of its assets and subtract all liabilities and debts to calculate net assets. While this has some merit for a business that has plenty of obvious tangible assets it becomes less useful the more important intangible goodwill is for a business. Things like market share, reputation, branding and expertise of personnel are very difficult to put a price on.

Because of these intangibles, it is usually recognised that net assets that can be priced with certainty will be less than the total market price a buyer might be prepared to pay for it. This is known as the goodwill element.

An asset based approach is normally more appropriate for poorly performing businesses.

Speak to an Expert

When it comes to valuing a business it’s best to get an expert opinion, the Corporate Finance team at Kay Johnson Gee have decades of experience valuing and selling businesses from a variety of industries, our most recent published deal was the sale of datacenter LDeX to Iomart, read the full press release HERE.

Contact one of our team today for a no obligation chat about valuing your business.