An average of 98% of business owners don’t know the value of their businesses.
Most businesses overlook business valuation because it takes time and cost. Overall, it seems impractical and out of reach. When valuing your business, you must account for various factors within your finances, or hire a professional to help you get through it.
However, it’s incredibly vital for you to understand the true value of your business, and not just when you’re selling it or getting investors.
That said, it helps when you understand what company valuation is, and the different valuation methods available. This guide breaks down seven most common valuation methods. We’ll guide you through how they work and how each one could be beneficial for your business.
How Do You Value a Company?
A business valuation is a process that determines the economic worth of a company. There are different approaches and different valuation methods. Still, each one has to involve the full assessment of every part of the business.
It’ll involve the costs of your liquid assets, equipment, property, inventory, and everything else of economic value. Apart from selling and acquiring new investors, you can also conduct company valuation when adding shareholders.
Also, consider it when establishing ownership percentages, or when merging with another business. The best valuation method depends on why a business needs valuation, the size of the business, your industry, among other factors. Let’s look at those different valuation methods.
1. Market Value Valuation Method
The market value valuation method is considered the most subjective approach. It determines the value of a business by comparing it to other similar businesses that have been sold.
For this to work, though, you need to be in an industry that can provide sufficient data on your competitors. This can be a challenging valuation method because all things considered, it may not be easy to find comparable data on similar companies.
This essentially means that it’s not among the most precise or reliable valuation methods. If you’re trying to sell your business or looking for investors, you may have to work with negotiations instead. It’s highly unlikely you’ll gain investors this way, and you’ll need a better approach.
2. Asset-Based Valuation
The asset-based valuation method is a lot more reliable. It considers all your total net business assets minus the value of the total business liabilities. There are two ways to approach this company valuation method, which are liquidation value and going concern.
If you intend to keep your business after valuation, you should go with the going concern method. This formula will account for the current total equity of your business, which is your assets minus your liabilities.
On the other hand, if you intend to liquidate your business after valuation, you should go for the liquidation value method. This method will be based on the cash value of your business. Consider how much you would have if you were to sell all your assets and terminate the business.
With this method, however, the value of the business is likely to be lower. Liquidation usually amounts to a lot less compared to market value.
3. ROI-Based Valuation Method
This method will evaluate the value of your business based on profits and your return on investments or ROI. You calculate the return on investments a potential buyer would get after acquiring your business. This is one of the most practical business valuation methods, but it still relies on the market, which also makes it subjective.
You’ll also need much more information to convince a client into buying into your business. This is because they will need to know how long it’ll take them to recover their original investment.
They want to see what their future returns look like, and how ambitious or realistic the numbers are. If you choose not to hire a professional, you can use the unit rate calculator to make these calculations easier.
4. Capitalization of Earnings Valuation Method
This company valuation method will calculate the future profitability of your business. It’ll be based on the current cash flow, expected value, and annual ROI.
This works especially well for stable businesses because the formula assumes the profits will remain constant. Essentially, the method will calculate the value of your business based on its ability to be profitable in the future.
5. Multiple Earnings Valuation
Multiple earnings valuation method determines the value of a business based on its potential to earn profits in the future. However, it’s also known as the time revenue valuation method.
It calculates the value of a business by multiplying its current revenue with a multiplier. A multiplier could be anything from the industry to economic factors, among other things.
6. Discounted Cash-Flow Valuation
The discounted cash-flow valuation method will value your business based on the projected cash flow, discounted to its current value. This is quite the useful method for businesses that don’t expect consistent profits in the future. However, this method also requires considerable details and significant, detailed calculations to work.
7. Book Value Valuation Method
Last but not least is the book value valuation method, which calculates the value of a business through its balance sheets. You will use your balance sheet to calculate the value of your business equity, and that value will represent your business worth. This is an excellent method for companies with valuable assets but low profits.
Should You Find a Company Valuation Professional?
Now that you know the different types of business valuation methods, should you still hire a professional? Working with a professional can be beneficial. They have a deeper understanding of what each method entails and what’s required to come up with an accurate figure.
A professional will offer you an objective examination of your business. They may also combine different methods, if necessary, to get the best results possible.
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