Placing a dollar value on your business may sound tricky but running it without one may be even trickier. Many business owners think a valuation only matters when it’s time to sell. Knowing how to place a reliable valuation on your business is a valuable tool, even if you aren’t planning on selling. Business valuations help for planning company growth, developing a tax strategy, securing a loan or investment, and more.
Many different factors determine overall business value including assets, reach, sales potential, and more. It can be very easy to over- or under-value a business without the right tools. Depending on the motivation for doing so, several methods exist for calculating business value.
Methods of Valuation
Calculating Valuation by Asset
Calculating business value based on company assets is just what it sounds like. Add up the total cost of replacing all business assets to determine this figure. The tools a business creates revenue with are its assets. This means even intangibles (such as trademarks and copyrights) have value and should be included in this figure. For companies operating online digital assets can include web domains, site analytics, contact lists, conversion rates and more.
- Pro: Straightforward valuation method.
- Con: Assets are not always reliable indicators of profitability. A high number of assets may not always mean a high business value, and a low number of assets is not indicative of failure. In the digital age, a more-comprehensive valuation method may be appropriate,
This method calculates a business value based on assets as well, just using a different formula. To determine the value of a business based on its liquidation potential, determine first the market rates of all company assets. Once these figures are available, total the sales-value of all assets to determine liquidation value.
- Pro: Simple mathematical formula for finding value.
- Con: As with the previous asset valuation formula, the total number of assets may not always be the best indicator of actual company value.
Market Valuation Approach
The best comparison for understanding this method is shopping the home market. To use the market-value approach, find other businesses similar in size and scope and compare to determine the value of your company.
- Pro: Good for non-traditional companies with limited assets.
- Con: The potential to over- or under-value a business using this approach is a bit high due to many overlooked factors.
Income-based approaches take a little more into account. There are two primary income-based approaches for placing a value on a business. First, reference previous sales data to predict potential future sales. This helps establish a value based on income potential. Values determined using this approach utilize years of sales data to arrive at this number. Financial records should always be accurately maintained and easy to access.
The second income-based approach includes much more data to create what is called a “multiplier”. A multiplier takes into account much more information such as company-provided benefits, earnings, buyer risk, business assets and more. Using the multiplier method, successful companies with assets and potential can command values several times net worth.
- Pro: Creates a thoroughly detailed and reliable figure for making decisions.
- Con: Time-consuming, potentially difficult to complete alone.
Using a Business Valuation
Once a valuation is determined business owners can make decisions based on reliable financial data. With a grasp of company worth owners are better able to:
- Hire extra staff
- Remain tax compliant
- Plan for growth
- Develop succession strategies
- Support banking and financing decisions
- Structure a functional buy/sell agreement
- Create an exit strategy and more.
Valuations are also important tools for the unexpected. The loss of a business partner, shareholder disputes, partnership troubles, and change of corporate structure are unplanned events that affect a business. Prepare with a comprehensive annual business valuation.
It’s OK to Ask for Help
A comprehensive business valuation is an exhaustive exploration of company assets, earnings potential, market share and more. There are many aspects affecting the value of your business. The same business may have very different values based on the method used. Do more with the help of a financial professional. At ProsperiFi we step back, looking at all the moving parts, helping business owners make informed business decisions. For these and more intelligent financial insights, visit ProsperiFi.com or call (847)292-4475.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.