How can you determine the economic value of your business? It’s possible to be in business for twenty years and not have to start a new business. Maybe you have been in business for only six weeks. You will likely need to determine the cash value of your company at some point. You are unlikely to be a financial expert so what can you do to determine the value of your company?
Why do you need to know what your small business is worth?
There are many reasons why you may need to value your business, including:
- The business is up for sale
- You are trying to attract investors
- you Are planning to sell stock in your company
- A bank loan is necessary for business
- You need to fully understand the growth of your business
Most of the reasons listed above are used for sales and investment. A business’ value is the ability to say to an investor, stakeholder, or buyer that it is worth X amount. If you want Y percent of it, you will have to fork over Z.
A business appraisal is essential for buyers and investors. To attract the attention of those who have the capital to invest in your business, you must show evidence of its value. How can an investor determine how much it is worth if you don’t show them how valuable your business is?
What method of business valuation is best?
There are many ways to determine the worth of your business.
“The most popular methods are the multiples or comp method, which is the easiest, and what’s known as the discounted cash flow (DCF) method (which is more complex,” stated Brian Cairns atProStrategix Consulting. “I recommend at minimum trying both.”
You will need to multiply the EBITDA(earnings before interest taxes, depreciation, and amortization) by the multiple of revenue. This will give you your current EBITDA. Cairns explained that the DCF requires you to forecast your earnings for the future (normally 5 years) and to calculate a net current value.
This article will be about the multiples method. These five steps will help you get a fair valuation of your company.
1. Forget about capital assets when valuing your business.
You may have mistakenly associated asset value with business value unless you are a chartered accountant or financial wizard. These two entities are distinct.
Here’s a common myth:
- Imagine your business owns a $500,000 office block, $100,000 worth of supplies, $200,000 in financial backing, and an $85,000 truck fleet.
- You have $885,000 total capital assets.
- You could sell everything right now for the cash value, which is how much your business would be worth.
All of the information above may be accurate, but it doesn’t define business valuation. It is not how much your business is worth. It is how much cash you have in your business. A buyer doesn’t care about how much they can make from your office block. They want to know how much they can make from the services and products produced there.
Also read: How to Generate Profit Multiplier for Your Consulting Business
2. Work out profitability by being aware of gross income and all outgoing payments.
If the value of your business isn’t measured in capital assets, then what is it measured in? Profits.
Valuing your company is all about the money you are making and the money you will make in the future. A buyer wants to know how much they can earn if they acquire your company
Your salary is calculated based on your gross income and outgoing payment. We don’t mean every penny you make from your business. This is just your base operating wage.Net Profit is what we aim for.
However, this is not all that we need. The income of a business does not determine its value. Two other important factors are also necessary for valuing your business:
1. Multiples: Multiples are longevity meters. If your company is worth selling, you don’t expect it to close down in one year. So how long will it continue to earn investors (or new owners money)? Multiples can be anywhere from 2-10 in the world of small businesses. The risk factor and the business size will determine the number.
Large corporations with solid foundations and long-lasting longevity are more likely to be able to multiply their profits by a large amount. However, for small and medium enterprises, multipliers between 2 and 10 are the norm. Your net profits can be multiplied by any number that is reasonable for your company.
2. Profitability adjustments: It is unlikely that a company will make the same amount of profit each year. You must calculate the expected profit growth and loss over the applied multiple when valuing your company. This can be done by reviewing historical financial data, market growth forecasts, and competitors’ performance.
It can be difficult to create a financial model for a small business if you don’t have good financial records. Abir Syed, a consultant in marketing at UpCounting, said that if you have historical data you can often have a financial model created for a small company in about a week. The model can be assembled in a matter of days for very simple businesses with all the necessary data.
3. Calculate the value.
This is the part that everyone hates: the math required to calculate your small business’ value.
“It shouldn’t take long if your bookkeeping is good, but if it’s in the middle liquidating capital assets as you prepare to execute an exit strategy that includes selling your business, it might take you months just getting prepared to do the math,” Jack Choros, finance writer PetSmart Investor.
Also read: How to Develop a Future Proof SEO Strategy for Your Business
First, establish your net income.
Add all expenses to your small business’ gross profit. Let’s say your business made $750,000 and you have $500,000 in expenses (travel, equipment, salaries) and left us with $250,000.
Second, look at multiples.
As we have already mentioned, the more risky or small-sized the business, you can expect a lower multiple. You must accept that you will need to do some guesswork and be subject to subjectivity in order to calculate your unique multiple. There is no one way to find a designated multiple. There are some basic rules to be followed:
- Do your research on the industry. How many other businesses in your industry have sold for similar prices?
- What is the financial health of your business?
- Is it stable enough for me to ask for a higher multiple?
- If you sell, what will happen to the business?
- Are you guaranteed any income in the future?
- How large is your customer base and how strong are your relationships with suppliers?
You must look at all your variables and make a decision on the basis of what your multiple should be. Here is a guideline:
- It is unlikely that a business owned by one worker will sell for more than three times its value.
- Companies with a revenue of less than $500,000 are more likely to reach five.
- Only companies with net profits greater than $500,000 can expect to achieve a double-digit multiple.
Our example shows that we have $250,000. annual net profit. Our expenses are $500,000, which means that we have a reasonable staff. Let’s say we fall in the second bracket, which would leave us with a multiplier between two and five. We’ll take four as our current value, which would be $1 million if we choose to play the middle ground.
Based on the potential growth, increase the value of your business. Although it sounds daunting, the process of finding this information is quite simple. However, accuracy will require time and energy. The following information is required:
- Your own historical growth (or those of your competitors, if they don’t exist)
- The growth of your market
The most important factor is historic growth. It is evident that your company has a history of growth. Take a look at your profits to see how they have changed. Let’s simplify this example.
- Our example company has seen its profitability increase by between 8% and 12% over the past five years.
- We value our business and expect 10% more growth each year across the x4 multiple selections.
Third, figure out your market.
The market is a major factor in your future profitability. Take, for example:
- If you are in a stable and established market, it is probably better to use historical figures as there is less movement.
- You have the opportunity to grow your business in a new market.
Also read: What is growth hacking vs. traditional marketing?
Fourth, determine your potential market growth rate.
Compare your growth rate to the market you are in. Let’s say your market grew 15% last year and your business grew 14%. Investors and buyers now have evidence to support the idea that they can expect similar growth to that predicted by industry experts.
You can assess market growth and the potential impact it has on your business by yourself. However, now is a great time to seek financial professionals or other business owners within your network for an additional opinion.
Finally, add growth projections.
Referring to the $1 million examples, we are not in a new industry; we are in the accounting sector. Because accountancy won’t see as much growth overall, we’ll use historical data to calculate our growth.
To increase your net profits, add 10% each year. To ensure precise numbers, multiply incrementally rather than adding 10% to the current figure.
- Year 1: $250,000
- Year 2: $275,000
- Year 3: $302,000
- Year 4: $332,000
This leaves us with a company value of $1,160,000.250.Investors and buyers will now know that our company is worth $1,160,000.
4. Factor in your market valuation.
Your valuation should be a guide. This valuation can be presented to buyers and investors to provide a fair and reasonable answer to the question “What’s your business worth?”However, this doesn’t necessarily mean that your business is worth the amount you have put into it.
Your business is worth whatever the market values it. Syed explained that market value can often be a reliable way to estimate value because it is a function of the assessment of all parties.
Our example business has been valued at $1.1million. Continue with this scenario:
- We have met with buyers and investors many times. We cite our $1.1 million valuations, but we can’t secure more than $1million.Investors agree with the valuation up to a point but do not accept the entire figure.
- Our business is worth $1 million.
It is unacceptable to accept a value that you can’t get the entire valuation amount from the buyer. Your business’s value is determined by the market. Investors don’t believe your business is worth $1.1million.
5. Accept the will of the market.
If the market isn’t supportive of your numbers, you may have to compromise on your numbers. You can’t afford to be stubborn if you are in desperate need of investment or you don’t have the time to wait to sell.
A business is only worth what it can get. Choros stated that if your industry is in trouble due to the coronavirus, for instance, your business may be valued at a higher valuation than what the market would. Even though your brand may be worth more, timing and the greater demand for your business in the market still matter. Your accounting records might show that your value is higher. Leverage is a key element of business.”You don’t always get what you deserve. You get what you negotiate.”
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