How to value a business
Key Takeaways
Valuing a business is a complex process that requires careful consideration of various factors
Consider consulting with a business appraiser or accountant to ensure an accurate and reliable valuation
Business valuations are dynamic and can change over time, so you should regularly review your valuation to account for changes in market conditions and business performance
For a very quick and rough guideline for how much your business could be worth, try our business valuation calculator
What is a business valuation?
Business valuations can help you to understand the true value of your business. They’re important if you’re selling or merging a company, raising capital, or making an acquisition, but can also help you to understand the financial health of your business.
The value of a business can be complicated, as many factors influence what a company is worth. Most valuations will take into account things like assets, future cash flow, and turnover.
How do I value a business?
There’s no one way to value a business, and seeking professional advice can help you decide how best to calculate what your business is worth.
Some common business valuation methods are:
An asset valuation is an assessment of the worth of your tangible assets. This might include things like your business premises, equipment, and stock.
To work out the value of your net assets, calculate your assets minus your liabilities (such as debts and any financial obligations).
Discounted cash flow (DCF) looks at the value of a business based on its expected future cash flow. It adjusts for the time value of money (i.e. the assumption that inflation will mean that your money will be worth more in the future) to calculate the future value of a business.
This is particularly useful if you have many intangible assets such as intellectual property which wouldn’t be accounted for in an asset valuation. It’s also well-suited to established businesses, where cash flow is predictable.
An entry valuation determines the value of the business by working out how much it would cost to create a similar company from scratch. It takes into account things like the cost of establishing a customer base, acquiring assets, and hiring and training employees. You’ll also need to look at how the business operates and think about ways that costs could be cut if it was started over. The projected start-up cost minus the potential savings gives you your entry valuation figure.
A comparable company analysis means looking at the valuations of similar businesses that have comparable earnings before interest, taxes, depreciation, and amortisation (EBITDA) as a benchmark to understand market value.
A price-to-earnings ratio (P/E ratio) takes your profits after tax and multiplies them by a certain ratio to calculate future profits. The ratio you use will depend on the nature of your business. Sectors with many high-growth start-ups like tech will have a high ratio, whereas lower-growth industries like bricks-and-mortar retailers will use a low ratio.
It’s worth noting that P/E ratio can only be used for public companies. Most small businesses and private companies won’t be able to use this to calculate a company’s value.
Asset valuation
Discounted cash flow
Entry valuation
Comparable analysis
Price-to-earnings ratio
There’s no right answer to what the best way to value a business is, and many valuations will use a combination of different methods. It’s best to seek professional advice if you’re unsure.
The steps of valuing a business
Valuing a business is a meticulous process that involves several critical steps. Each step is vital to ensure an accurate and fair valuation. Here’s a breakdown of the key stages:
Examine the company's financial health through its balance sheets, income statements, and cash flow statements. This initial step provides insight into the business' past and current financial performance.
Use various approaches to determine the business's worth:
Market-based approach: Compare the business to similar companies in the industry that have recently been sold or are publicly listed
Income-based approach: Focus on the business' potential future earnings, discounting them to present value
Asset-based approach: Calculate the value based on the sum of assets minus liabilities
Engage a professional appraiser to review the data and apply their expertise. This step ensures that all aspects of the business are considered, and the valuation is aligned with current market conditions.
Understand the business's financial statements
Apply different valuation methods
Finalise the valuation with a professional appraisal
Factors that influence the value of a business
Several factors significantly impact the valuation of a business. Including:
Profitability: A profitable business with consistent earnings is generally more valuable.
Growth potential: Businesses with strong growth prospects tend to be valued higher.
Market conditions: Economic conditions and industry trends can impact the value of a business.
Management team: A skilled and experienced management team can increase a business' value.
Debt and liabilities: High levels of debt can reduce a business' value.
Why value a business?
Valuing a business is essential in several scenarios. A business valuation:
Offers a clear financial overview for buying or selling a company
Demonstrates the business' value and growth potential so that you can seek investment
Builds a picture of both companies in the case of mergers
Ensures that you meet legal and regulatory compliance requirements
Helps you to complete proper financial reporting
Minimises legal risks
Next steps after valuing your business
Once you have valued your business, it's vital to use this information effectively. Here are essential actions to consider:
Make informed strategic decisions: Use the insights from the valuation to shape your strategy. Consider expanding into new markets, enhancing product lines, or streamlining operations to increase profitability.
Negotiate sales or investment offers: With a clear understanding of your business' worth, you can negotiate better with potential buyers or investors. This ensures you receive fair value for your business.
Plan for future assessments and maintain value: Conduct regular valuations to monitor your business' progress and adjust as necessary. Keep an eye on market trends and internal performance metrics to help maintain or enhance your business' value over time.
📣 Remember: Valuing a business is a complex process that requires expertise. Consider consulting with a professional business appraiser or accountant to get an accurate valuation.
