5 Commonly Used Business Valuation Methods
It might be necessary to assess the value of your business at some point. You may need to do it for a business venture or sales process. Several business valuation processes are available to help you accomplish that. We’ll discuss the various business valuation methods and the pros and cons of each process.
You can choose the method that will best benefit your business after you read about your choices. We’ll cover the five most popular methods and give you the information you need to learn about those methods.
What Is Business Valuation?
A business valuation is a process by which a business owner assesses the company's current worth. Owners can use a variety of processes and methods to calculate the value. What's most important is that the valuation includes all aspects of the business.
It's essential to have an accurate business value so that the business owner knows the limitations of his or her ability to perform various movements.
Why Would You Need Business Valuation?
One of the main reasons to conduct a business valuation is to satisfy tax requirements. The IRS demands that business owners have their properties valued at fair market value. All taxes are calculated based on that value. However, there are numerous other reasons you may want to value a business. These are some of the most common:
To Sell Your Business
You would want to have an accurate analysis of your business's value if you intend to sell it or involve yourself in a merger or acquisition. As a business owner, you'd want to ensure that you get as much money as possible for the empire you created.
To Request a Loan
Another reason to have your business valuated is if you need to borrow funds from a lending institution. You may want to expand your business or add a new unit to one of your properties. You may want to remodel your business or purchase newer equipment to keep your workers and visitors safe. Furthermore, you may be interested in forming a partnership with another company. Loans to accomplish such tasks usually involve a great deal of money. That means the prospective lender will want to secure the loan it gives you. Having a recent valuation will let the prospective lender know how much the business is worth and whether it's a wise idea for them to invest in lending to it.
To Gauge Your Potential Growth
A business valuation is not always for the purpose of securing a loan. Sometimes, business leaders want to assess their financial growth and learn their potential for future growth. You can learn a lot from the analysis. You'll learn how far you've come along and how likely your business is to continue to grow a number of years from now. It's good information to have when you're seeking to motivate yourself to keep striving for success.
To Get the Right Amount of Insurance
Another reason for a business valuation is for insurance purposes. You need to know how much your business is worth so that you can request the appropriate amount of coverage for that business. Insurance providers will only pay the funds stated in your policy. For example, you'll only receive $100,000 for a loss if you only purchased a $100,000 policy. You won't' get a penny more, even if your business is worth $200,000 or more. Therefore, it's crucial that you have an accurate figure in front of you when you speak to an insurance agent. You can't go wrong if you get your business valuated first.
To Plan Your Retirement
Maybe you're thinking about retiring, and you want to know if you can do so comfortably. That's a perfect reason to assess the value of your business. You can have someone assess it and then decide whether it will be profitable for you to sell it and retire. It might just be a good time for you to do that. The valuation will give you all the information you need to know about where you stand.
Five Most Common Business Valuation Methods
As stated before, you can use numerous methods to assess the value of your business. The following are five of the most common ways companies do so:
The Liquidation Valuation Method
The liquidation method is probably the quickest and easiest method to use to determine what your business is worth. In this method, someone calculates the current value of all the business's assets to come up with a cash figure that the company would receive today from a buyer. That total is then reduced by all the liabilities the company owes. The figure that's left is the liquid value of the company.
The benefit of using this method is that it's straightforward and simple. Generally, you could come up with the figure quickly.
The downside to using this method is that acquiring appraisals of all your business assets can be costly. Additionally, this method doesn't factor in the potential future earnings or income.
The liquidation valuation method is best used by a business that intends to sell quickly. However, it's acceptable to use this method if an owner wants to have a general idea of what the business is worth for another reason.
The Market Comparison Approach
Another one of the common valuation methods is to use the sales transactions and data from other companies in the market to create a value for the business. Here, the valuation expert would not use any of your business's information except data about the type of business you run. He or she would examine several similar businesses and then come up with an average value based on the collected data.
This approach might be a good one if you're looking for a rapid valuation with only minimal scrutinization of your company's books. It uses real-life data from other companies and can provide you with a highly accurate figure.
The downside to using this method is that it might be difficult for the person doing the valuation to find information on private companies. Also, the findable data could be somewhat unreliable. It all depends on the field your business is in and how accessible those records are.
This method could work very well for you, but it could also be a bit off. It is best for getting a general idea of what your business is worth just so that you'll have the information. It might not be the best method to base a strategy on.
The Market Capitalization Approach
Another one of the valuation methods involves looking at your shares. Using this method, you would first determine your company's share price. Then you would look at your outstanding shares. The calculation would be done by multiplying your share price by your shares outstanding. For example, your business is worth $700,000 if you have 5,000 shares outstanding, and your share price is $140.
Some say that this method is the best and most accurate method to use to evaluate your business. This method gives a pretty clear-cut measurement of the size of the business right now.
The downside is that shareholders' actions may fluctuate in the future. Thus, it's best to use this method for business ventures that you'll conduct in the near future.
Times Revenue Method
The times revenue method is yet another one of the popular valuation methods. This method uses a stretch of income that your business made during a period of time. It looks at the actual revenue that your business earned in a previous fiscal year, for example. It then uses a multiplier to come up with a figure by which it multiplies your earnings to create a value. The multiplier depends on the environment and industry. It could be a figure like .5 or 3x, depending on the circumstances.
This method has some benefits and disadvantages.
The benefit is that it can give you a quick snapshot of what your business might be worth for a negotiation.
The downside is that it's not always the best indicator in terms of accuracy. Your revenue is not always equal to your profits. For that reason, the times revenue method may be less accurate than other methods used.
This method is better suited for younger businesses that may not have many earnings. It also might be better suited for a company that's looking to expand in the near future. Otherwise, some other methods may work a little better.
Earnings Multiplier Method
The earnings multiplier method may be a more accurate method to use than the revenue multiplier method. It uses the business's actual profits instead of its earnings. This method looks at the same time period, except it uses an entirely different process. It looks at future profits against potential cash flow investment at the current interest rate. In simpler terms, it uses the price-to-income ratio to account for the current interest rates. This method is good for comparing a business with other entities in the market.
The five methods mentioned above are several out of many options. It's up to you to decide which way your business should go to have it valuated. You'll want to choose the most accurate method so that you know a precise figure for making important business decisions. You can use a variety of specialists to perform this action.
Who Can Valuate Your Business?
You have many options to choose from when it comes time to hire someone to evaluate your business. The following are some of the many professionals you can hire for this sensitive task:
You could use a business adviser if that person has had a lot of exposure to business sales. At the very least, an advisor knows the current state of the market.
Accountants are good people to go to because they know all about the assets and books. You should first try to hire your company account to do it. He or she will already be familiar with your business operations and their value.
You can consider hiring business brokers to give you a valuation figure. Business brokers deal with business sales all day long. Therefore, they have more knowledge about current market trends than other providers have.
You could hire professional certified valuers who have special certification for performing business valuations. These calculations are their specialty, and they are the most likely to give you an accurate figure.
You could evaluate your own business if you want a rough idea or ballpark figure. For example, you can use information from newspaper clippings and internet listings. These will give you a general idea of what business owners are asking for their businesses in your field. However, they won't tell you what the businesses actually sold for. It might be a good idea if you want to get a quick feel for how your business might sell. Another option would be to use an online business valuation tool. The tool will use the information you put into it to come up with a figure.
How to Find the Best Company for Business Valuation?
You'll need to hire the most reliable person to evaluate your business, no matter what reason you want it evaluated. You can find a valuation company using a variety of methods. Business associates, financial advisors, and attorneys can steer you the right way if they can't help you with it themselves. You should always look for the following qualities in the provider:
Experience
The individual or entity that you use for your business valuation should be seasoned and experienced. An experienced professional will know the best approach to take to evaluate your business appropriately. Look for a provider who has at least a decade of experience
Positive Reviews
You'll also need to look for positive input from other organizations that have used the same provider. You can feel confident using a provider who has a rating of three stars or more on a five-star scale.
Accolades
Accolades should also factor in heavily when you're searching for a provider to do your business valuation. Look for material on the provider's website that indicates it is a legitimate firm with notable achievements. You may want to look for awards or affiliations with prominent financial organizations, for example.
Transparency
Examine the provider's personality when you reach out to them. You'll want to hire a company that cares about getting your business the figures it needs.
You should find a reliable provider if you look for all the above-mentioned qualities. You can trust that the provider will perform high-quality work.
Contact Us for More Information
You should now have a fair amount of information about business valuation and what you need to do to determine how much your business is worth. Don't hesitate to reach out to us if you need to have us answer additional questions for you. We are advocates of individuals and small businesses trying to improve their financial profiles. You can find a variety of instructions, educational materials, loans, and more through our company. We are not a lender, but we're always connected to many reputable lending institutions.
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