Small business owners invest significant time, effort and passion into building their business. This clearly comes with a lot of personal pride and emotional attachment, which is priceless. But what is your company actually worth in terms of pounds and pence, how is it calculated, and what factors contribute to its value?
Business value is calculated in several ways such as an asset-based approach, average market multiple, discounted cash flow, and price-to-earnings. Financial performance, the type and age of assets, internal operations, industry type and growth potential also affect a business’s value.
Having a good understanding of the value of your business is essential, especially if you are considering selling, looking for outside investment or planning for succession.
Business valuation is not an exact science, and many factors influence the calculation. At Spotlight Accounting, we have a great deal of knowledge and experience in using different business valuation methods, which we will share in this blog post.
What is a business valuation?
A business valuation is the process of determining the the market value of your business. It is an in-depth assessment that looks at several factors to establish an estimate of what a business is worth.
Business valuations are often carried out to facilitate the sale of a business, mergers and acquisitions, obtaining finance, internal strategic planning, exit planning purposes, and, sometimes, settling shareholder disputes.
How are business valuations calculated?
Let’s take a look at the various methods used to calculate the value of a business.
Financial statements and financial records
This method involves financial analysis of a company’s financial affairs using historical financial data. This process involves a detailed examination of accounting records, such as the profit and loss account, balance sheet, and cash flow in and out of the business.
Assets and Liabilities
This is a calculation of the value of tangible assets (property, plant and stock) and intangible assets (intellectual property, reputation and goodwill) after deducting the liabilities such as loans to establish the net asset value.
It is critical to understand the relevant industry as market trends, competition, and economic conditions can significantly impact the value of the business. Comparisons will be made with similar businesses in the same industry.
This valuation method is based on the company’s ability to generate profits. It involves applying multiples to the company’s earnings, such as the price-to-earnings ratio, which is the value of a company divided by its post-tax profits.
Discounted Cash Flow (DCF) analysis
This method of valuation estimates the present value of the business’s future cash flows. It looks at future cash flow and uses a discount rate to bring them back to their present value.
This is where recent sales of comparable businesses are used to provide a benchmark business valuation. This type of market valuation is often most appropriate for small businesses.
Intellectual property and intangibles
If a business owns intellectual property such as internally developed computer software, a strong brand this can increase the business’s worth.
A business with a strong management team will have a higher company valuation than one where the departing business owner is significantly involved with the day-to-day operations.
Future growth prospects
A business with a clear plan and untapped market share could be deemed more valuable.
What factors influence business value?
Several common factors affect the value of a company, regardless of the business valuation method used.
A business that consistently demonstrates revenue growth and strong profit margins relative to its industry will be more highly valued.
Positive cash flow and the ability to forecast cash flow will also help increase the valuation.
Robust financial statements and a healthy balance sheet also have a positive influence on business value.
A business with new tangible assets (e.g. plant and equipment) will be worth more than one with dated or obsolete assets.
Intangible assets, including brand recognition, customer base and intellectual property, can increase the value of your business.
Liabilities such as loans and other commitments will have a negative impact.
A long-term, loyal customer base and a history of repeat business can enhance a business’s value.
Industry and market conditions
A business operating in a growth industry, such as technology, will have a higher value than one in an industry in decline. The market position of the business in comparison to its competitors will affect its value.
Market conditions also affect buyer’s demand. If the business is in an industry with an abundance of potential buyers, the valuation will be higher than one where there is no hunger to purchase. This can also extend to the wider economy.
Future Growth Potential
A business with a clear and achievable growth plan will have more value. Also, a business that has been investing in developing products and is at the infancy stage of a new version is deemed more valuable.
Similarly, a business with a growing recurring revenue stream will have more value than one that has where the market is already saturated.
Legal and regulatory
Evidence of failure to comply with legal and regulatory requirements can negatively impact the value of the business.
Potential uncertainties, liabilities, operational risks industry-specific risks are taken into account when valuing a business.
As mentioned above, a business with a strong management team is likely to be valued more highly than one where the owner is heavily involved in the day-to-day running of the business.
Recent investment in technology and processes can also increase a company’s value.
How can Spotlight Accounting help you?
Valuing a business is an art, not a science. Our team of experts works with business owners to create business valuations and offer valuable insights on how to maximise their company’s full potential.
We take it further than producing a valuation report; we like to understand the goals of a client. For example, a business looking to find a buyer through a business broker is significantly different to one that is looking to grow and nurture a team to eventually buy the existing business owner out.
If you are looking to exit, we always recommend taking professional advice to make sure you get the best return and outcome for your investment.
Don’t hesitate to get in touch with us today.
Frequently asked questions about business worth
How many times its profit is my business worth?
This depends on your financial records, future growth potential and the industry in which you operate. Different business valuation methods, such as price-to-earnings ratio and average market multiple, use different multipliers depending on your business performance and other factors.
How much is a business worth based on turnover?
Most businesses are valued on a multiplier of net profit, as turnover does not indicate the return on a buyer’s investment. The only exception is if your business operates in a market where the market method of valuation is based on turnover, e.g. some service-based industries.
What is the typical cost for a business valuation?
This depends on the complexity and size of your business, who is carrying out the valuation and the business valuation methods used.
Who pays for a business valuation?
This depends on the transaction being undertaken. If a buyer approaches a seller, then it is normally the buyer who instructs an independent valuer. However, if it is a valuation for an internal transaction, then it is the company that covers the cost.