If you’re selling up or looking for investment, you maybe wondering: What is my business worth?
Looking at your turnover and multiplying it by a number is not the way to work out its value.
We saw such a situation many years ago regarding the valuation of a business when a sale was being considered.
The managing director wanted around £1 million for the company, which was turning over £700,000 annually. The figures were vague and all ended in zeros, so it was difficult to trust them, but post-tax profits were just £10,000.
It was clear the business owned few assets, including intangible assets (such as goodwill and reputation). With a tiny order book and no marketing in place, the value of the directors was nowhere near £1 million.
Eventually, the value was something like £20,000-£30,000 – most of that being in stock – as the business also had debts. There was a huge difference between the company’s real value and the hopes of the directors! The business wasn’t worthless and could have been turned around, but the directors were never going to part with it for its real value.
This illustrates that there’s more to valuing a business than just its financial position.
There are a number of valuation methods that are used in valuing a business. This guide looks at the commonly used techniques.
The multiples of earnings is often used as a method of valuing a business. It’s a useful method for companies with an established financial history.
A Price/Earnings (P/E) Ratio uses the value of the business divided by post-tax profits. For example, a business with a P/E ration of four that makes £50,000 in post-tax profits would be valued at £200,000.
But arriving at the right P/E ratio number varies drastically depending on the business. At the moment, tech or ‘green’ start-ups have a high P/E ratio as they are considered high-growth companies. A mature company, such as a retailer, will have a lower P/E ratio as they have slower growth.
This is one of the simplest ways of valuing a business. To reach the value, you work out how much it would cost to set up a similar business to the one being valued.
You need to make a note of all the start-up costs and the tangible assets it has today. Then, you consider the cost of developing its products, building a customer base and recruiting and training staff.
Consider, too, the savings you could make when setting up. For example, could it be located in an area that is cheaper? Could the materials used be sourced for less? You then subtract that from the figure.
Once you’ve taken everything into account, you have the ‘entry cost’ and, as a result, a valuation.
Longer established businesses with lots of tangible assets are more suitable for these valuations. Manufacturing companies are particularly suited to valuation on assets.
Start with working out the Net Book Value (NBV) of the business. These are recorded in the company’s accounts.
Remember to consider adjusting what the assets are worth now because they will have changed. For example, old stock depreciates and if there are debts, they reduce the value of the business.
If a company owns its buildings, consider that value, too. In light of the pandemic, some commercial property may now be worth less than before the outbreak.
Discounted cash flow
This complex valuation of a business focuses on assumptions about its future. It works by estimating what future cash flow would be worth today.
One way to reach valuation is by adding the dividends forecast for the next 15 years, for example, plus a residual value at the end of the period.
You calculate today’s value of each future cash flow using a discount rate, accounting for the risk and time value of the money. This is based on the idea that £1 today is worth more than what is likely to be tomorrow because of its earning potential.
The discount rate can be anything from 15 to 25%.
In industries where business change hands regularly, industry-wide rules of thumb are often used. As you can imagine, it relates to the current rule of thumb of the industry. Such valuations are based on more than profits because they consider customer base and number of outlets. This is often how retail industry companies are valued.
We know of one business that supplies products to the building industry. Ten years ago, it was a small player in the market but it is currently growing quickly. Some of this is due to pricing but it’s also thanks to intangible assets, namely supplier/customer relationships.
By focusing on quick delivery and excellent service, customers left its larger competitors who were too slow and unreliable. As well as turnover and profits rising, the intangible asset of its relationships has increased its value considerably.
If this business were selling tomorrow, its value is much higher now because buyers have the prospect of cementing those relationships. As a result, it can offer more profitability and a more valuable company.
With so many ways of valuing a business, it can be difficult to choose the best. Get an accountant or business broker to help if you are serious about selling.
One area all business owners should consider is record keeping. A business is more valuable if you have kept clear, accurate records. Why? Well, these prove that you are not just plucking figures out of the air.
Of course, many records must be kept legally, but don’t forget to keep and store them accurately. Using software such as Xero helps as it is real-time information and a potential buyer knows your current situation.
Without records in place, buyers will fear you’re not telling the whole story.
If you’re thinking, ‘What is my business worth, contact us today to talk about valuing your business