Business Valuation is the key to determining the value or worth of a business. In this fast-changing economic climate, every business needs to have an up-to-date business valuation on hand at all times. Even if your business was valued only a year ago, it probably won’t have the same value today as business values go up and down. Therefore, it has become imperative to keep a close track of business value.
Business Valuation gives business owners the ability to create a practical timeline for the potential sale of business and for other exit strategies. It provides a road map about how to adjust their short-term or long-term business goals and when to pull back in certain sectors or push forward in another.
Here are five steps which can help you to establish your business worth:
1. Planning and Preparation
Just as effective planning and preparation leads to running a successful business, attention to detail and careful organization of information leads to successful business valuation. The two key factors in establishing your business worth are:
Determining need for valuation
Assembling all imperative information
2. Adjusting the financial statements
Business Valuation is basically an economic analysis of a company. Companies provide financial information by deriving key inputs mainly from the two financial statements income statement and balance sheet. As business owners have considerable discretion in how they use the business assets as well as what income and expenses they recognize, the company historical financial statements need to be adjusted. The aim is to construct an accurate relationship between the required business assets, expenses and the levels of business income assets are capable of producing. Therefore, for an accurate valuation of a business, 3-5 years of historical income statements and balance sheets need to be adjusted.
3. Choosing the Business Valuation Approach
Applying the appropriate business valuation method or approach is very crucial for successful business valuation of a business. There are mainly three business valuation approaches - asset, income, and market. Under each of the three approaches to determine business value, there are a number of procedures called Business Valuation Methods which are used to calculate business value. Each business valuation approach offers a different view of what a business is worth because of the difference in procedure and mathematical details of each business valuation method.
Asset Approach
The asset approach considers the assets and liabilities as building blocks of the business to construct the picture of its value. Under the asset approach, the value of a business is determined based on the fair value of assets minus liabilities. There are two bases on which asset-based business valuations can be done: Going-concern asset-based approach and Liquidation asset-based approach.
Income Approach
The income approach determines the value of a business based on its income-producing capacity and risk. There are two business valuation techniques under the income approach, capitalization and discounting. The technique rates capture the risk involved in a business. Income approach determines the fair market value of a business by measuring the current value of projected future cash flows. It derives this value by multiplying cash-flow of the company by its appropriate discount rate. The most commonly used business valuation methods are:
Discounted Cash Flow
Multiple of discretionary earnings
Capitalization of earnings
Market Approach
Under the market approach, business value is indicated in comparison to historic sales involving similar business. The business valuation methods under market approach are:
Comparative transaction method
Guideline publicly traded company method
Both the above methods work by comparing the subject company to similar company that are sold recently. Business valuation method under the market approach relies on pricing multiple which determines the relationship between business economic performance and its potential selling price. Pricing multiple are determined by the sales of businesses which closely resemble the business being valued. Statistical analysis of such actual business sale data is used to establish the business valuation market comparable.
4. Applying the Selected Valuation Method
Once the financial statements are carefully compiled and adjusted, the selected business valuation method should calculate accurate business value. Calculating the business value using several business valuation methods helps to cross-check your assumptions.
5. Reaching the Business Value Conclusion
After calculating the value from the selected valuation methods, we can make the decision of what the business is worth. This is called business value synthesis. As no valuation method provides the definitive answer, we can use results from different business valuation methods available to form opinions of actual value or worth of business. Different business valuation method produces different results, therefore concluding business value demands these differences to be reconciled.
Deriving a business value conclusion requires using a weighing scheme for various business valuation methods. The weights assigned to the results of various business valuation methods serve to rank their relative importance in reaching the business value conclusion. Since there are no defined set of rules for determining the weights, business valuation experts use a number of guidelines while selecting the weights for their business value conclusion:
Asset-based approach is given emphasis in the weightings when the business is asset rich and detailed business asset value data is available.
Income-based approach is given emphasis in the weightings when business earnings projection exists and future business is expected to differ substantially.
Market-based approach is given emphasis in the weightings when relevant comparable business sale data is available and Minority(non-controlling) business ownership interest is being valued.
ABOUT THE AUTHOR:
Bharat Kanodia is the founder of Veristrat. He has been in business valuation since 2000 and has valued assets in real estate, industrial, personal property, and financial assets including some unique assets i.e., the Golden Gate Bridge, NYC subway system, Hartsfield Atlanta Airport, and Las Vegas casinos. He has signed off on over 4,500 valuations with $2.6 trillion in assets globally. You can learn more about his tactics on his YouTube channel, “What’s It Worth?" Bharat lives in the San Francisco Bay area with his family and enjoys sailing, golfing, skiing, and horseback riding.