Do You Know Your Business’ Worth?
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Perhaps you’re a seasoned entrepreneur with a portfolio of business interests and you have your sights set on a promising new enterprise. Maybe you’re a neophyte whose seen their startup business through its first couple of years and are curious about the enterprise’s worth. Maybe you just feel as though your passion for your business or industry has begun to wan and you want to determine the value of the operation so that you can make an informed decision whether to stick it out or to get out while the going is good.
There are many reasons why entrepreneurs may want to undertake a business valuation, and whether you have your eye on the back door or are simply professionally curious, you want to ensure that your valuation is accurate. You will likely want to enlist the aid of a mergers and acquisitions company to carry out the valuation or you may simply want to do a rough estimate yourself to satisfy your curiosity. Either way, it pays to have a working understanding of the facets which determine a business’ value. While there’s no set formula for working this out, there are some reliable indicators of a business’ value and proven methods of establishing it…
Discounted cash flow
This determines the value of the business based on its cash flow over a prescribed period of time. This is then added to the “terminal value” of the business outside of this time period after it has expired. The combined figure is then discounted to provide a tentative valuation of the business. This is fine for an overview but is rarely the most reliable indicator of value as it relies heavily on estimations and predictions.
Entry cost
This method has a fairly simple premise. How much would it cost to create an identical business with the same resources today? This would take into account the value of the business’ fixed assets such as its premises and equipment as well as the cost of developing the products and services and training employees. It also takes into account the marketing and promotional costs associated with building the brand’s reputation and “goodwill”.
Earnings Multiples
If your business has a long and storied financial history, it’s value may be estimated based on multiples of your earnings. This is one of the most commonly used valuation techniques, applying the formula of business value divided by post-tax profits. This is referred to as the Price / Earnings ratio. Let’s say your business turns an annual profit of $100,000 and you are offered $400,000 for the business. Your Price / Earnings ratio would be 4:1.
This ratio will vary depending on the size, nature and given industry of your business. Businesses with rapidly rising profits will likely have a higher earnings multiple whereas nascent startup businesses or smaller enterprises will have a lower one. Likewise, growth industries such as tech and IT will also command a higher Price/earnings ratio. Smaller businesses are often in more volatile markets, presenting a greater risk to a potential buyer. Thus they can expect a lower P/E ratio.
