You don’t have to be selling up to wonder about the value your business. There are a number of reasons why you may need to know what it’s worth, which is its economic value.
Knowing the value of your business is useful even if it’s to simply understand the financial health of your business. But there are many other reason why you might need to value your business.
Our handy guide will help you understand why it’s worth valuing your business and an outline about how to do it.
Why value your business?
There are many reasons why you need to value your business. And it’s not just when you want to sell up and retire. You may want to value your business because:
- You want to secure funding for your business. A valuation gives investors a realistic estimate of its value. For example, if you’ve watched Dragon’s Den, a lack of awareness of the value of a business can make it less attractive.
- It gives an overview of the financial health of your business. This is useful in pinpointing areas that are underperforming so you can work on it and help your business grow.
- Putting a price tag on your business helps if you are succession planning or are ready to sell-up.
- Your staff want to buy shares in the business. You can’t do that fairly if you don’t really know what the business is worth in financial terms.
Whatever your reasons, valuing your business is worthwhile and can also stimulate your management to work on increasing its value.
Valuation methods
You can value your business using a number of methods.
Asset valuation
For those whose business has sizeable assets, an asset valuation could be the best option. Assets are classed as ‘tangible’ or ‘intangible’. Tangible assets are those that physically belong to your business, such as stock and equipment. Intangible assets are those that are not physical. For example, your patents, intellectual property and brand reputation are intangible assets.
Multiple of profits
This is also known as the price/earnings ratio. This method compares the price of company stock to the profit a buyer might expect to make from it. It’s suitable for businesses with a good track record of profitability.
It includes adjusting monthly or annual profits to exclude extraordinary events, such as one-off costs and purchases. This gives a good idea of the future profits that can be expected.
You then add on any further costs or gains the business makes after it is sold or invest in. This produces a final profit figure, known as ‘normalised profit’.
Once you have the figure, you multiply the figure by three to five to obtain a price-earnings ratio, which is standard practice. The price/earnings ratio can be compared with other companies in your industry – and this will give an indication of how realistic the value is.
A high price/earnings ratio can show that a stock price is high and the business could be overvalued. Too low, and the price/earnings ratio indicates the business could be undervalued.
Discounted cash flow
This is one of the trickiest methods of valuing a business. But it is said to be US investor Warren Buffet’s preferred methods and is useful for businesses that can project stable and predictable cash flows for years ahead.
It estimates what a future stream of cash flow is worth today. This valuation is the sum of the dividends forecast for each of the next 15 years or so plus a residual value at the end of the period.
To reach the present value of future cash flow, a discount interest rate is applied to cover any risk and time value of money. This value is represented by the idea that £1 earned today will be worth more than £1 gained tomorrow due to its earning potential.
Comparables
This is quite a popular way to value a business. That’s because you compare your business to companies that are similar and have sold in recent times or its value is in the public domain.
It’s very much like using Zoopla to figure out the value of your house! While the property is comparable, it’s not necessarily exactly the same, but it gives an indication of its value.
Rule of thumb
Some industry sectors have their own formula to use when valuing a business. For example, in retail, the value of a business is usually valued as a multiple of turnover, customer volumes or number of outlets.
On the other hand, other companies, such as estate agents, are valued by the number of outlets alone.
If you would like to value your business, then our team at Concept Accountancy can help. Contact us today for details.
