Business valuation can be a powerful tool during price negotiations when selling your company. There are many reasons businesses use valuation, from establishing partner ownerships to divorce proceedings. Businesses use a variety of methods in the valuation process, such as asset-based approaches, earning value approaches, and market value approaches. Each has its own unique set of benefits which can make it a good option for certain types of businesses. Learn more about business valuation, its benefits, and why you should speak with a business consulting firm for assistance.
What Is Business Valuation?
Business valuation is generally performed when a company is interested in selling all or a portion of its business operations. Valuation may also occur when a company is looking to acquire or merge with another company. Valuation can be highly useful when determining the current worth of a company. In a valuation you will often see a variety of information about the inner workings of a company, such as its capital structure and its prospective future earnings. Approaches often include a review of financial statements and similar tools used for comparison purposes.
Business valuation works similar to an appraisal for a residential home sale. A business appraiser inspects and analyzes the business as a whole. The process often includes valuation of assets. Companies can be valued in a number of ways based on the unique circumstances surrounding the valuation. When a company is offered for sale, more than one valuation method is often used in the valuation report. You may be wondering why you need a business valuation. In short, it is a wise idea to have an up-to-date business valuation available and update it every year in case there is a major change in your business operations.
In What Ways Can a Company Be Valued?
- Times Revenue Method: With this business valuation method, company revenues that are built over time are applied to a multiplier based on the economic environment and industry
- Market Capitalization: This is one of the easiest valuation methods. This method involves multiplying the business’s share price by the total outstanding shares
- Earnings Multiplier: This method adjusts potential future profits against cash flow which could be invested at the existing interest rate over a set period of time. The earnings multiplier is often used to get a more accurate idea of a company’s real value
- Discounted Cash Flow: Similar to the earnings multiplier, DCF is based on future cash flow projections. The biggest difference between the profit multiplier and discounted cash flow method is that the profit multiplier considers inflation when calculating present value
- Liquidation Value: Liquidation value is the net cash that a company will receive if all of its assets are liquidated and the liabilities were promptly paid off
- Book Value: The book value is the value of the shareholders’ equity of a business and is based on the balance sheet statement. This value is found by subtracting a business’s liabilities from its assets
What are the Benefits of Business Valuation?
There are a number of benefits that come with using business valuation methods. When done properly, a valuation can help reduce the risk of business disputes and can provide a value that can be used as a basis for tax purposes. A business valuation tells a buyer the maximum amount he or she should pay for a company. It can also tell a seller the minimum price he or she should sell the company for. Having this information can be invaluable during the buying and selling process.
If you have a partner that is looking to leave your company, business valuation can be useful. A valuation provides business owners with an accurate value for the partner leaving to be bought out. Business valuation also functions as a powerful decision-making tool. Business owners are better able to choose the best time to market their business based on market changes. This allows business owners to sell their company at the highest price possible. Finally, business valuation can be highly beneficial for business owners looking to grow or merge their companies.
What are the Differences Between Standards of Value & Premises of Value?
Some of the most important components of appraisals relate to standards of value and premises of value. In standards of value, there are four main standards of business value including investment value, fair market value, intrinsic value, and fair value. Fair market value is most commonly used by business appraisers and is defined as the price in which a property is sold to a willing buyer who is not under any compulsion to buy and has reasonable knowledgeable of associated facts. Investment value refers to the value in which a specific buyer would pay for a property.
There are two main premises of value: liquidation and going concern. Liquidation occurs when a business has no or bleak future operating prospects and the value of the business’ assets are netted with the value to transfer liabilities to acquire residential value. The fair market value of a company could be based on liquidation if the business was able to sell its assets and liquidate at a higher price than could be justified by the likely future cash flows. Going concern relates to an operating business that continues to produce cash flow.
Learn More About Business Valuation
If you are preparing to buy or sell a company, or perform other actions that would deem a business valuation useful, you may be considering what methods are best. Before making your decision, it is important to know that the value you find is relative. Like all businesses, your company is unique and your value may not accurately reflect the structure of your business. To get the best value price, it is a good idea to conduct a business valuation several years before a sale and continue to update it yearly. To learn more about business valuation or for assistance performing a business valuation, contact a business consulting firm today.