Business Valuation Methods

Estimating the value of your business is crucial when you need to report your taxes, be open to new investors for your business, or even when you want to wrap up and sell your company. All these factors are dependent on what your company is worth. Business Valuation is adopted by Venture Capital firms, entrepreneurs, investment bankers, and retail investors to assess the company’s financial worth. This can come in handy when trying to sell your business or raising funds to accelerate your company’s performance. Although professional guidance is recommended to proceed with your business valuation process, it is certainly worth having comprehensive knowledge of how it works. Read on to know why you should consider valuing your business and the different types of valuation methods you can employ based on your company’s needs.

What exactly is a business valuation?

Business Valuation is a process in which you estimate your company’s or business’s economic value. A thorough research and assessment of the properties, total assets, net income, overall shares, revenue, outstanding shares, inventory and predictions are required to proceed with the valuation process.

Out of all the purposes that a business valuation process serves, the primary one is to take cognizance of your economic position in the market.

Why do you need a business valuation?

There are a few reasons you would need a business valuation; you might need to sell your company to avoid debts, or you need a merger to accelerate your business or avoid bankruptcy. Sometimes, the business you run is open for new investors and shareholders to reserve more funds. Or do you have more space financially to acquire a whole new company? Any of these cases need a business valuation of either your own company or the one you are eyeing to take charge of. There might even be tax-related issues that can be addressed with the valuation of your company. Whatever the case, business valuation is an important tool and solution for any circumstance.

Note: You should initiate the valuation process even for divorce proceedings where the spouses may have been business partners before separation or are looking to add or remove the partner by settling their finances.

Remember to analyze the purpose of estimating your business values and research the possible outcomes before you start the valuation process. There are numerous business valuation methods and the seven best methods are explained here for your understanding:

Market Value Method

The Market value method of valuation works on the simple principle- the value of your business in comparison to many such similar ones in the market tells you a lot about the economic worth of your company. You can apply this method by multiplying the count of outstanding shares of your company by the price per share at present.

Business value = company shares ×total outstanding number of shares.

One of the main disadvantages of adopting this method is that extracting competitor data can be a challenging task. But if applied, the market value method can help you garner funds for prospects.

Capitalization of Earnings

Based on the Gordon Growth Model principle, the capitalization model works for companies making steady profits and income. In this method, you must consider your company’s potential to make profits and returns in the future to value your business. A good understanding of the company’s P-E (Profits and earnings) ratio is needed before you apply this. While depending on the uncertainty of prospects may be a disadvantage, using these predictions can help you find investors with better funding.

Asset-based Valuation

As the name suggests, the valuation is dependent on the total asset of your company, excluding the liabilities. There are two ways you can apply this method: the first is the Going-concern approach, where you are planning to continue operating the business. The value you get by deducing liabilities from assets will help you seek funds or mergers with superior clients or investors. The second way is the liquidation value which happens when your company is on the verge of closure or bankruptcy. In such cases, you should consider the net value of your assets during the termination stage only.

Discounted Cash Flow (DCF)

This method of valuation involves the evaluator making assumptions about how much income your company can make in the future with the current investment. The cash flow prediction is modified to the present investment value with an average discount rate. Also called the income approach, this method allows you to keep minimal expectations of profits.

If the DCF value is greater than the current income value, the signs can be perceived to be positive.

Although there can be inaccuracy in prediction as it focuses completely on the future, the DCF valuation is one of the most common methods of business valuation.

ROI based valuation

The Return on Investment method is a basic valuation process where you consider the returns your investors can expect based on your company’s growth and market trends. If the investors can receive the returns in a shorter period of time, the value of your business goes up. This method, again, is applicable for companies looking to scale their business better and not those planning to sell their company.

Book value

This approach is solely based on the Balance sheet of your company. You can calculate the net value by deducing the liabilities and intangible assets from the total asset of your company. This is favorable to small Businesses making lower profits as the estimated valuation outcome is usually lower than the market values. Since you cannot rely entirely on metrics, comparing the book value with the market value is advisable.

Multiples of earnings

The multiples of earnings valuation method is a bit similar to the Gordon Growth valuation model, where both depend on the potential revenue the business makes. But this approach adds a multiplier value to the present revenue to calculate the valuation estimate. This is ideal for new companies where you can compare the lowest possible price with the highest price. It is highly dependent on market trends. The main disadvantage is that your revenues need not necessarily be profits.

For example, If your company makes $70million in revenue and is ready for sale and the industry trend suggests a 5 times revenue in the next year, your business value is $70m × 5= $350 million.

Summing up

Though considerable knowledge of the business valuation process is essential for every business owner, you cannot expect accurate valuation without the guidance of an expert. We, at Eqvista, aim to simplify your complex accounting and valuation processes by bringing to you all the apt methods to your notice and determining what suits your company the best. It is recommended to use two or more valuation types while assessing your business value. Get on a free consultation call with us to know what your company is worth!