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Business Valuation

Knowing the valuation of your business is essential for acquisitions, exit-planning strategies and the general health and well-being of your company. And if your business is family-owned, you might not even understand the total value of what you have created. That can lead to a decline in value later during the selling process.

What is Business Valuation?

Business valuation is the process of determining the economic value of your company. This information can be used by business owners, investors, and other stakeholders to make informed decisions.

Business valuation is usually conducted when a company is planning to sell all or a portion of its operations, or intending to merge with or acquire another company. The process of a business valuation involves determining the current worth of a business, using objective measures, and evaluating all aspects of a business.

Methods of Business Valuation

The valuation of a business can be a complex and a subjective process. But there are several methods that can be used to arrive at a fair market value. Here are some of the common approaches used to value a business:

1. Asset-Based Valuation— This method calculates the value of your business by adding up the total value of your assets and subtracting the total value of your liabilities. This method is commonly used for companies that have a significant amount of tangible assets, such as real estate or equipment.

2. Earnings-Based Valuation — This method estimates the value of your business based on its potential to generate future income. There are several techniques used in this approach, such as discounted cash flow (DCF) analysis and capitalization of earnings. DCF analysis involves projecting the future cash flows of your business and discounting them back to their present value. Capitalization of earnings entails dividing the expected annual earnings by a capitalization rate, which is the rate of return that investors would require for investing in your business.

3. Market-Based Valuation — This method estimates the value of your business by comparing it to similar businesses that have recently been sold. This approach is commonly used for businesses that are similar to publicly traded companies or have a significant amount of goodwill.

4. Times Revenue Method — Under the times revenue business valuation method, a stream of revenues generated over a specific time frame is applied to a multiplier that depends on the industry and economic environment. For example, a tech business might be valued at 3x revenue, while a service company is valued at 0.5x revenue.

5. Earnings Multiplier — The earnings multiplier can be used to obtain a more accurate picture of the real value of your business. For example, your company’s profits are a more reliable indicator of financial success than sales revenue is. The earnings multiplier will adjust future profits against the cash flow which could be invested at the present interest rate over the same amount of time. In short, it adjusts the current P/E ratio to allow for current interest rates.

Factors that Influence Your Business Valuation

Once a valuation is performed, it is important to understand the factors that can impact the value of your business. Some of the key factors that can affect the value of your business include the quality of its financial statements, the strength of its management team, its market position, its competitive landscape, and the industry in which it operates. Analysts will also include factors such as company leadership and future earnings in determining the valuation.
In addition to these factors, there are several other considerations that can affect the value of a business. For example, a company with a strong brand and loyal customer base may be worth more than a similar company with a weaker brand. Similarly, a company that has a long-term contract with a key customer may be worth more than a company that relies on a more unpredictable customer base.

Importance of Business Valuation

Even if you don’t intend to sell your company soon, knowing your business’s worth can provide you with additional insights that will inform future business decisions. As an example: do you have a substantial amount of money tied up in inventory? This insight could alter how you manage inventory procedures in the future.

The valuation of your business is also a critical component of any transaction involving the sale, purchase, or merger of your company. By understanding the different methods used to value your business, the factors that can impact its value, and the other considerations that need to be taken into account, you – and your investors — can make informed decisions about the value of your company. Ultimately, having an accurate and up-to-date valuation can enable your business to achieve its financial goals and maximize its long-term success.

Drilldown Solution Can Help Your Small Business Accounting Needs

When it’s time to do a valuation of your small business, look to DrillDown Solution for it to be done accurately and efficiently. We will make the business valuation process run smoothly and ensure that it doesn’t take you away from your ownership responsibilities.

Our accounting services are designed to reduce your administrative and bookkeeping burdens and provide you with valuable financial benchmarks for your business. This results in keeping you updated and informed.

Our goal at Drilldown Solution is to put your small business in the best financial position possible, utilizing proactive processes and personal care!

Note: The material and contents provided in this article are informative in nature only. It is not intended to be advice and you should not act specifically on the basis of this information alone. If expert assistance is required, professional advice should be obtained.

Ed Gabriel, CPA is President of DrillDown Solution and a graduate of Brigham Young University. His clients benefit from over 40 years of experience in maximizing profits, minimizing taxes and putting them in the best financial position possible.