Perhaps, the best place to start in determining the market value of your business is to understand why it is important.
Apart from the most popular reason for knowing the worth of a business which is selling it, many business owners don’t see any other reason why they should go through the trouble. But there are many other reasons, in my opinion, these two stands out; the first is that it gives you an objective view of your business.
When the value of your business is determined, you get brutally honest feedback from the market about your business; what drives its value and what weakens it. It also gives you a view of what value lenders might place on your business (especially when you want to use the business as collateral for a loan).
The second reason is that an appraisal of the worth of your business helps you as a business owner look beyond day-to-day operations to how you can create long term value for your business.
Now, that you have some reasons for determining the market value of your business, how do you go about the process?
There are varying methods of determining the worth of a business, here are 3 you can use:
Do a Rough Calculation of The Value of Your Business
You can sum up the value of your business‘s assets and subtract the sum of your liabilities from it, to get a balance sheet estimate of the value of your business. But you shouldn’t stop there, determine the amount your business makes in sales/revenue per year and use that value to estimate how much businesses in that sales or revenue class might be worth. This is just a rough estimate and may certainly not give you an accurate representation of what your business is worth but it can give you an idea.
Discounted Cashflow Analysis
The Discounted cash flow analysis is used to estimate the value of a business based on its projected cash flows. That is, it estimates the value of a venture by making predictions of how much money it will generate in the future and then discounts the value of the future cash flow to today, using a “net present value” calculation. The formula for DCF is:
DCF = The cash flow of year 1 (CF1) ÷ 1 + discount rate (r) + The cash flow of year 2 (CF2) ÷ (1 + r) ^2 + The cash flow of year additional year (CFn) ÷ (1 + r)^n
Earnings Multiple Analysis
An earnings multiple may be used to provide a guide to the valuation of a business. In this case, the earnings of a small business are multiplied by the earnings multiple to determine the value of the business.
The formula for calculating Earnings Multiple = EBIT or EBITDA × Earnings Multiple.
EBIT/EBITDA – Earnings before interest and taxes / Earnings before interest, taxes, depreciation and amortization.
Earnings Multiple – is usually between 1 to 10 depending on the risk attached to the future earnings and growth of the business; market position and management strength may impact such risk evaluation.