March 7, 2022 | 3-minute read (514 words)
Business valuation is the process used to determine the economic value of a business and to provide owners with an objective estimate of its value. This is done by assessing factors such as operating assets, intangible assets and cash flow. Once owners have an accurate idea of their business’ worth, they can make better decisions and capitalize on new successes.
Frequently, a business valuation happens when an owner is looking to sell their business or to merge with another company. It may also be used as a tool for making investments, applying for business loans and sharing equity with employees. Sometimes the business valuation proves useful when starting a business partnership or when buying out an existing partner.
Preparatory steps before selecting a valuation method
To come up with an appropriate business valuation, first get your documentation in order by:
1. Classifying intangible assets:
Assign an estimated economic worth to nonphysical assets such as firm reputation, brand awareness and intellectual property.
2. Organizing financial records:
Have your balance sheet and cash flow statement on hand.
3. Defining a target for your business’s value:
Regardless of whether you intend to sell, establish a target so you can keep track of growth and develop future expectations.
After you’ve accomplished the above, consider how you could imbue more value into your brand by modifying expenses and whether you can better employ intangible assets.
Three methods for deriving business valuation
The asset, market and income approaches are the three primary techniques for valuing a business. For the most accurate valuation, you may wish to consider aspects of all three.
1. The asset-based method:
To get a basic valuation, subtract your company's liabilities from the total worth of its assets. This will likely match the value on your balance sheets.
Because the asset approach doesn’t fully account for intangible assets and additional costs like benefits and rent, it is best for small firms with a small crew and low operational costs.
2. The market method:
With the market approach, you analyze the value of similar assets on the market to come up with an estimated value for your own business. This approach can be used to determine the worth of individual assets, such as real estate and equipment, or of your business in its entirety.
This method can also help businesses to identify their net debt, using a ratio that compares cash flow to debts. Be sure to make adjustments based on risks or benefits unique to your business that may affect its overall value. For example, patents, a good reputation or a high market share could boost valuation.
3. The income method:
With the income approach, you use income and revenue projections to determine business value. Once this figure is derived, it can be adjusted to account for factors such as expected growth periods, changing tax rates and market downturns.
The income method is best suited for businesses seeking a valuation to help with growth. The resulting valuation may indicate a need to boost marketing or enhance product lines in order to achieve your goals.