A business valuation is the process of determining the economic value of your business.
This involves assessing both tangible and intangible assets. Valuation often includes financial analysis, market research, and industry trends.
The purpose of valuing a business is to determine its fair market value, which can be used for various purposes including:
- Buying and selling a business
- Raising funds from external investors
- Making decisions on mergers and acquisitions
- Identifying weaknesses and opportunities
Think of it like this—when you buy a house, you need to know the estimated value of the property to determine how much to pay. Business valuations work in a similar way.
Business Valuation Methods
You can use several business valuation methods to get an accurate idea of the worth of your small business.
Each has advantages and disadvantages, so choose the one that best fits your needs.
Market Capitalization
This method is used to determine the value of a publicly traded company. It involves looking at the company’s current stock price and multiplying it by the number of outstanding shares.
This gives you an estimated market capitalization, which can be used to compare your company to similar ones.
The advantage of this method is that it provides an up-to-date snapshot of your business’s worth in the eyes of investors.
The disadvantage is that external factors, such as market fluctuations, can affect it.
This method is challenging for small businesses because we’re not publicly traded.
Times Revenue Method
This method uses the company’s revenue to estimate its value.
It involves multiplying the annual revenue by a specific number, usually between one and three, depending on the type of business.
The advantage of this method is that it gives you an idea of how much your business earns in relation to its size.
However, the downside is that it doesn’t consider other factors, such as cash flow, profit margins, and market trends.
Earning Multiplier
This method is used to calculate the value of a business based on its income. It involves multiplying the company’s net earnings by an industry-specific multiplier.
Here are a few of the different popular multipliers.
EBITDA Multiplier
This method is used to estimate the value of a business based on its earnings before interest, tax, depreciation and amortization (EBITDA).
It involves multiplying the company’s EBITDA by an industry-specific multiplier. Again, specific industries have different multipliers due to cost structure and other factors.
To put it more simply, EBITDA is your earnings minus your expenses.
Sellers Discretionary Earnings Multiplier
This method calculates a business’s value based on its Seller’s Discretionary Earnings (SDE).
The main difference between the EBITA multiplier and the SDE multiplier is that the latter considers the owner’s salary and other discretionary expenses.
It involves multiplying a company’s SDE by an industry-specific multiplier.
Again, to put it simply SDE multiplier is EBITDA + adding back what you (the owner) paid yourself.
This is particularly popular if an owner-operator paid themselves a TON of money year after year, but you (the person acquiring the business) would only have to pay a modest salary to hire someone to replace them.
Discounted Cash Flow
The discounted cash flow method calculates a business’s value based on future cash flows. Future earnings are discounted to account for the time value of money.
It involves forecasting the company’s cash flows over a certain period and discounting them back to present value using an appropriate rate of return.
The advantage of this method is that it considers expected growth and other factors, such as interest rates and inflation.
However, it can be complex to calculate, requiring extensive research, analysis, and forecasting.
Enterprise Value
This method is used to calculate the value of a company based on its enterprise value.
Enterprise value includes the company’s market capitalization, debt, and cash. It does not include any intangible assets, such as intellectual property.
You find the enterprise value by subtracting the cash and debt from the market capitalization.
The advantage of this method is that it considers both tangible and intangible assets. However, it can be challenging to estimate the value of intangible assets accurately.
Book Value
This method is used to calculate the value of a company based on its book value.
Book value is the total value of all assets minus liabilities, which gives you an idea of how much the business would be worth if it were liquidated.
This method is straightforward but doesn’t consider intangible assets or future growth potential.
Liquidation Value
This method is used to calculate the value of a business if it needs to be liquidated.
It involves calculating the total value of all assets minus liabilities and any outstanding debts.
Usually, the liquidation value is lower than the book value as it does not include intangible assets such as intellectual property.
An upside to this method is that it’s easy to calculate and gives you an idea of what your company would be worth if it had to be sold quickly.
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