What Goes into a Business Valuation?
If you are hoping to sell your business in the near future, it is important to have a good idea of how much it is worth. Unfortunately, the business owner is usually not the best person to determine this value. He/she is too close and has too much invested in the business (both financially and emotionally) to be an objective evaluator. For this reason, it is always recommended that you bring in a professional to perform a business valuation.
Asset Value: Determining the value of the assets of a business can be done in one of two ways:
- Add up the value of all assets the business owns (such as real estate, vehicles, plant, equipment, computers, cash, etc.) and subtract all liabilities.
- Figure out the liquidation value, the estimated amount of cash you could raise if you sold off all the assets today, and subtract all liabilities from that amount.
The liquidation value is likely to be lower, depending of course on the current market value for the assets the company owns.
Earnings Value: An earnings evaluation is usually taken to determine what the business can reasonably expect for future cash flow. Once this figure has been reached, the estimated future business expenses are subtracted to determine the company’s projected net profit.
Arriving at an accurate earnings value can be difficult because you cannot predict with 100% certainty future revenue growth. This is often where the business owner is quite a bit more optimistic than an outside observer. The evaluator will look at past earnings, average annual growth/decline, present market conditions and trends, the overall stability of the business itself, and any other relevant factors depending on the specific industry.
Market Value: A market valuation of a business is similar to estimating the market value of a piece of real estate. In both instances, comparable recent area sales are used to arrive at a price. The challenge with valuing a business this way is that there are usually not enough recent sales of comparable businesses in the area to provide a reliable figure. But market value can still play a role in the overall business valuation.
After the business evaluator is able to consider net assets, net earnings, and market value, they are able to come up with an amount that the business owner can reasonably expect to sell for. Of course, whether the owner will actually receive this amount always depends on current market conditions at the time of sale but the business valuation gives the owner a realistic expectation going into the process.