Your business is like your child. You’ve nurtured it and helped it grow right from the beginning. Like children who grow up and are ready to leave the home nest, businesses too can outgrow their owners and may be ready to be put up for sale. Alternatively, after the success of your current business, you might look to buy another one. You may also want to negotiate better terms or make a purchase or sale more quickly.
Other reasons for wanting to value your business include raising equity capital, create an internal market for shares or even motivating your management and boost their performance while recognizing and identifying areas that need improvement. Whatever your reason may be, you’ll be wondering how to quickly value a company.
In this case, this post is for you! We take you through some of the most common business valuation methods, besides other considerations which you may need to consider so that you can work towards your business goals.
1. Value of net assets
To determine the value of your net assets, you first need to specify all of your assets (tangible like land and buildings/property, machinery and equipment, tools, cash on hand, and more). You then need to subtract all your liabilities from the value determined by calculating the net realisable value of all your assets.
Asset valuation starts off by determining the Net Book Value (NBV) of the business. In practice, this could mean determining the price of the property/fixed assets, which would need to be sold at a discount; old stock (also to be sold at a discount); and bad debts or those which are expected to remain unsettled.
Then there is the question of liquidity – will you be selling off your assets to get more cash in hand? If so, equipment that may be sold at an auction could only achieve a fraction of its book value; debt collection could become a more cumbersome process; there are costs of closing down your premises; and in addition, you may also have to take redundancy payments (should these apply to your case).
Unfortunately, the valuation of net assets doesn’t take into account intangible assets such as the value of the brand, the company’s reputation, its “goodwill” if you may, trademarks, logos, intellectual property, and more. What’s more, is that intangible items such as software development costs are also typically excluded from this type of valuation.
2. Discounted cash flow
This valuation method is used for businesses that are relatively stable and expect to earn a relatively stable amount over a longer period of time, such as 15 years into the future or more. When you work out your business’ estimated future income into a formula, you can set a value of the business in the present. However, it depends heavily on assumptions about long-term business conditions.
This method works out what the future cash flow would be worth today. It assumes that £1 today buys more than £1 tomorrow, owing to inflation.
So, how can you calculate your business’ discounted cash flow? Here are the steps:
- Add up the dividends forecast for the next 15 years (or more)
- Add a residual value at the end of the period
- Apply a discount to determine today’s worth: this discount rate may range from 15% to 20%
Some argue that if the estimated value is higher than the current cost of investment, the chances are that the investment opportunity is worthwhile. Experienced investors often use this valuation method, including the likes of Warren Buffett.
3. Entry cost
The entry cost valuation refers to the valuation of a business should it choose to start over from scratch. The related costs in this calculation that will need to be added up include:
- Start-up fees
- Recruitment, employment and training
- Tangible assets and asset building
- Development of products and services
- Marketing and developing a client base and reputation
In this calculation, you can also factor in savings you can make through streamlining. This can include the use of better technology or even relocation to a less expensive area.
4. Price-to-earnings ratio/The multiple of profits
The price/earnings (P/E) valuation method, also known as multiples of profits, is best suited for businesses with a solid track record of profitability and established history.
It works by comparing the price of a company’s shares to the value of the company’s earnings. There’s a division between public and private companies and how they use this method to get a quick business valuation. For public companies, the P/E ratio will be calculated by dividing the price of the stock by the earnings per share. For private companies, you need to multiply your profits by a ratio figure (ranging from 2 to 25 – the smaller the business, the lower the ratio).
Keep in mind that you will need to adjust your monthly or annual profits in order to exclude what is termed “extraordinary events” which may include one-off purchases or costs. This will help give you an idea of your future profits.
The higher the forecast profit growth, the higher the P/E ratio.
5. Industry standards
Another way to value your business quickly is to use established industry standards. Here are some guidelines for you to consider, depending on your industry:
- IT businesses are usually valued by turnover
- Retail or food and beverage companies are valued based on the number of outlets, volume of customers or a multiple of turnover
- Computer maintenance and mail order businesses are almost exclusively valued by turnover
- Mobile phone airtime providers are valued by the number of customers
- Estate agency businesses are valued by the number of outlets
6. Comparable business sales
You can also value your business based on other business sales of similar businesses over a similar period to determine the amount that your business would be worth. You can check out the information that’s available in the public domain. Factors to consider here are the business’ location, its turnover, customer base, asset base, etc.
For example, the principles of valuing and calculating average house prices can apply to valuing businesses, too.
7. Other considerations
As the last point, consider valuing your business quickly based on current and projected economic conditions. The economic climate will affect the risk appetite of an investor, resulting in more caution being exercised during a downturn, or more demand for business growth and higher prices when the economy is booming. Check out factors such as inflation and interest rates, business and economic growth. in order to value your business according to the economy.
And there you have it! Seven simple ways on how to value a business quickly. In order to start, you need to be fully aware of your business’ assets and liabilities, profits, earnings, and projected earnings, future losses through depreciation of assets or bad debt, etc. Although all these numbers might confuse at first, it’s always wise to sit together with an accountant to help you value your business quickly so that you can sell it, grow it, purchase another one, stimulate management with more incentives for improved performance, and more.