Determining the value of your small business is the process of assessing the total economic value of your business and its assets today. It’s a necessary practice for every big financial event in a small business’s lifetime including when you’re applying for loans, considering a transfer of ownership, or you have interested buyers. Whatever your reason, here are four business valuation methods you might use for determining what your business is worth.
Calculating the book value of your business is as simple as subtracting the total liabilities of your company from the total assets. This is a useful tactic to determine business worth for businesses with low profits but valuable assets on file. After doing the math, if you find that you have a negative valuation (where your liabilities are higher than your assets), your business would be considered “worthless.” In this case, you might want to consider paying off debts or increasing assets.
The disadvantage of using this business valuation method is that it doesn’t consider your business’s future earning potential. So, while it’s simple, it may not produce a full picture of your business’s worth.
Another method to calculate value is an earnings multiplier. The idea behind this method is that a business’s value is in its future ability to produce wealth. In most cases, a multiplier is applied to your earnings before interest and taxes (EBIT). To calculate your EBIT, you would take your total revenue and subtract the costs of goods sold and operating expenses.
The challenge is then in determining the multiplier which is usually a number between 2 and 7. While you could research multipliers by industry, working with a business appraiser can help you find an accurate multiplier. They’ll take things like business size, industry, market trends, and business brand into consideration.
Using the Market Value method, you’re calculating the value of a business based on the selling price of similar businesses. This method looks at the most recent sales of similar businesses and makes adjustments for the differences between them.
However, there are limitations with the market value method. It may be difficult to find comparable sales or, if the sales data isn’t recent, it may not be relevant to the current market value. This method works best for businesses that have significant access to this data on their competitors.
Discounted cash flow
And finally, the discounted cash flow (DCF) method is the most complex. It estimates the value of a business based on anticipated cash flows. This method uses projections of what a business will generate in the future and is adjusted for the time value of money, which assumes that the dollar is worth more today than it is tomorrow.
First you would determine your company’s weighted average cost of capital (WACC). This is a complicated formula but there are online business valuation calculators that can help you determine your WACC number. Once you have this number, you apply your cash flow projections to reach the value. This method doesn’t require you to do competitor research but it relies on assumptions about future growth. Changing your assumptions can lead to radically different future cash flows. If you choose to go down this path, it might be best to hire a professional to help you.
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