How to Value a Business: Understanding Its True Worth

When you’re planning to exit, merge, grow or make future plans for your business, understanding what it’s worth is likely going to be your primary concern.

When it comes to valuing a business correctly there’s no simple formula that will give you a definitive value, as many factors are in play. In this article we are going to explore the most common approaches to valuing a business, what can impact the number, and how you can use this insight to plan your next move.

Valuing a business requires proper consideration of not just past performance but also current conditions and likely future potential. Of course, potential risks that could be on the horizon play a part too. Valuing a business accurately therefore requires a holistic approach and using rule of thumb and average industry values will often provide a mis-leading answer.

The Importance of Accurate Business Valuations

Creating an accurate valuation allows you to make informed strategic decisions regarding expansion and diversification or if you’re looking to secure the sale of the company.

Exiting a business is a process. There are various steps to go through if you’re going to achieve maximum.  Understanding your current valuation compared with where you want it to be is the start of the process. It will help you understand what changes you need to make before you sell in order to get the best price and the level of interest that you will need.

Investors will want to scrutinise your valuation assumptions to assess their potential return on investment.

Business Valuation Approaches

Income Based

There are two main income based methods used:

  1. EBITDA – Earnings before interest, tax, depreciation and amortisation is used as a proxy for the cash the business has historically generated. As a backwards looking measure it is probably the most commonly used method that suits businesses with solid income streams that are not expected to change.
  2. Discounted cash flow (DCF) analysis – This route looks at the present value of future income streams and is more often used where significant growth is expected (via new products/markets etc). Future income is estimated and then discounted to represent current value. The discount applied will vary upon the cost of money as well as the risk a buyer perceives to your future income streams market/product innovation, management team etc).

This approach heavily focuses on cash flow and how well equipped the company is to generate it for new investors in the future.

Market Focused

This approach takes a look at the corporate landscape and looks to compare the company against similar organisations based on revenue, profits, or assets.

Average market multiples come into play here. This allows potential investors to compare companies on a like-for-like basis. This could include looking at earnings, book value, or simply headline sales figures. The risk is that unless your business is average you may under estimate its value.

Asset Focused

Here, the value is derived from the company’s assets and liabilities. This includes the book value of assets or the liquidation value, considering what the company owns versus what it owes.

If the company owns a lot of high value machinery or property this can be a popular avenue when it comes to valuing the business as that represents almost guaranteed value, unlike future sales forecasts.

Business Valuation: Influencing Factors

The Financials

Revenue trends, profit margins, cash flow, and stability over time significantly impact valuation. Consistent growth and recurring revenue are valued by investors and therefore can result in a higher valuation.

The Market

No matter what you’ve achieved in the past or how solid the situation looks on paper, the market is the market and it can either help you or prove to be a huge hindrance.

Economic, social and political factors all have a constant impact on your outlook. An investor will likely want to know how these pressures could impact the future of the business and how changes in the level of volatility could affect operations.

IP and Competitive Advantages

What do you own?

Unique assets, patents, intellectual property? Some other kind of competitive advantage?

Of course, this can play a massive part in your business valuation, even if you have low revenues. Potential can be pivotal if it’s protected.

Risk

Which brings us on to risk.

Assessing risks associated with industry-specific challenges, market competition, regulatory changes, and management stability can impact your company’s valuation.

Investors and buyers of businesses like stability matched with potential.

Get a Valuation For Your Business

Business valuation is a nuanced process, there is no one size fits all.

To understand exactly where you are, you need to talk to an expert who can assess your situation from all angles.

This is especially important if you’re looking to sell as they will be able to help you maximise the value of your business whilst working to a timeline that suits your needs.

At Business Partnership we can provide you with a free valuation today.

There’s never any obligation, it is always confidential, simply find out what we could achieve for you. Call our team on 0207 145 0040 or find your local contact here.

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