Business Valuation is a general process of determining the economic value of a whole business or company unit. It can be used to determine the fair value of a business for a variety of reasons, including sale value, establishing partner ownership, taxation, and even divorce proceedings.
How do you calculate the overall worth of your business? You might have been in business for a long period without ever having to do it or you might just be starting out. At some point, will definitely need to place a cash value on your brand. If you’re looking for investors or you wish to sell your business, you will need to determine its value.
Follow these five steps to calculate your business’s value.
Step 1: Forget about capital assets when valuing your business.
Unless you’re a qualified chartered accountant or a financial expert, you may have made the common mistake of associating asset value with business value. In fact, these two entities are completely different.
Here’s the common misconception:
Suppose your business has an office space worth N500,000, goods and products worth N100,000, financial backing of N200,000 and a truck worth N85,000.
In total, you’ve got N885,000 in capital assets.
If you were to sell everything now, that is the cash value you’d receive from selling, so that is what your business is worth.
While all of the above information may be correct, it isn’t what is meant by business valuation. It’s not what your business is worth ‒ it’s how much cash is tied up in your business. A buyer isn’t interested in how much money they can make if they sell your office block. They are interested in how much money they can earn through the products and services produced there, I hope this is clear please.
Step 2: Work out profitability by being aware of gross income and all outgoing payments.
If the value of your business isn’t measured in capital assets, then what is it measured in? Definitely Profits.
The valuation of your company focused on the income you are earning and the money you are likely to earn in future. A buyer wants to know how much they can expect to earn if they take over your company.
With gross income and outgoing payments, your own salary is included in that. However, we aren’t talking about every cent you earn from the business, just your base operating wage. Net profit is what we are aiming for but that isn’t all we need. A business is not valued based on its income for a single year. We also need to consider two more important aspects for valuing your company:
Multiples: Multiples are longevity meters. You don’t expect your company to go out of business in a year if it is worth selling, so how long is it likely to keep going and earning investors (or new owners) money? In the small business world, multiples range from two to ten. This number depends entirely on the risk factor involved and the size of the business. Larger corporations, with solid foundations and longevity estimated in the decades/centuries, are likely to achieve high multipliers, but for your common variety, small and medium enterprise, a multiple between two and ten is the accepted norm. You multiply your net profits by whichever multiple is reasonable for your company, that’s what makes the major sellable worth of the business 👌
Profitability adjustments: A company is unlikely to generate the exact same profit year after year. When valuing your business, you must determine the amount of growth or profit loss you can expect over your applied multiple. To do this, you’ll need to examine historical financial data for your company (if you have it), your market’s expected growth and your competitors’ progress.
Step 3: Calculate the value.
This is the step that everyone dreads: the actual mathematics required to calculate the value of your small business.
“It shouldn’t take long if you do proper bookkeeping, but if you’re in the middle of liquidating capital assets because you’re getting ready to execute an exit strategy that involves selling your business, it may take you months just to get ready to do the math, this is an eye-opener! Try to always keep your business financial records.
First, establish your net income.
To do this, take your small business’s gross profit and subtract all expenses. For example, suppose your business brought in N750,000, with N500,000 in expenses (equipment, travel, supplies and salaries), and we are left with N250,000.
Second, look at multiples.
As mentioned before, the riskier or smaller the business, the lower the multiple you can expect to achieve. To work out your unique multiple, you need to accept that there is some guesswork and subjectivity involved. Unfortunately, there is no set way of finding a designated multiple.
Step 4: Factor in your market valuation.
Your valuation is a guide. You’ve created a valuation you can present to investors and buyers, providing them with a reasonable and respectable answer to the questions of “What is your business worth?” But that doesn’t mean your business is actually worth the value you’ve put on it.
In the end, your business is worth what the market says it’s worth. Market value is often a very accurate way to estimate value, as it’s a function of the assessment of all other parties and all other information available,
For example, if you have valued your example business at N1.1 million. Continuing with our scenario:
If you meet with investors/buyers several times. While you cite your valuation figure of N1.1 million, you cannot secure more than N1 million. The investors agree with the valuation to a point, but they do not accept the full figure.
N1 million is now your business value.
- If you cannot secure the full valuation amount from the buyer(s), then it is not an acceptable value. The market dictates your business’s overall value. If investors don’t think your business is worth N1.1 million, then the business isn’t worth N1.1 million. You must learn how to pitch them brilliantly
Step 5: Accept the will of the market.
You may need to compromise on your figures if the market doesn’t support them. If you need investment to survive or you can’t wait to sell, then you cannot afford to be stubborn with your numbers.
“A business is only worth what the market demands. If your industry has fallen on hard times, due to the coronavirus, for example, you may value your business at a much higher valuation than the market would. Things like timing and the greater need for your business within the marketplace still matters, even if your brand might be worth a lot more money, or your accounting records may show that you are worth more. Business is always about leverage. You don’t often get what you deserve, you get what you negotiate.
I’d love to hear the questions you have!—please post them in the comments!