How to value a business – common methods

If you want to sell your company at some time in the future, how do you know what it is worth? Even if you don’t use ‘traditional valuation methods’ when conducting a sale, it is vital to be able to demonstrate to a would-be buyer that you have an accurate and robust knowledge of all aspects of your business operation, and the underlying finances.

Before you undertake a business valuation, you will need to full documentation of the financial history of your company. You’ll need to have records of all of your past and projected costs, revenue, cash flow and profit for all of your years of operation. It’s important to have an accurate value of a company’s assets, and the exact amount of any debt owed by the business.

All of these elements are always crucial, but there are a number of different ways you can choose to value your business. The basic principle is that a company’s worth is the sum of its propensity to earn, minus reasonable deductions for costs and extenuating factors. But there are different ways of arriving at a similar figure.

Method 1 – Profit Multiplier

Adjust your average annual profits to exclude anomalies. These anomalies could be one-off deals, the likes of which won’t be repeated, or one-off costs which are unlikely to be incurred again. Take into account your average rate of growth and you will have a good idea of the money you can expect to make over the coming few years.

This figure of average annual profit (adjusted to factor in future growth) should then be multiplied by 3, 4 or 5 to give your company a value. There will usually be an industry standard as to which of these numbers is your multiplier, but generally speaking, the larger the company and the better its reputation, the higher the number for multiplication will be.

Method 2 – Assessment of assets

A really quick way of giving your company a ‘net-book’ value is by simply subtracting the total liabilities on your company from the total value of the sum of its assets. The assets will have to be valued at the current rate, so this method does not take into account external factors such as inflation or depreciation of assets.

Method 3 – The rebuild

Another model of valuation is simply to look at how much it would cost to rebuild the company from scratch. How much would it cost to train all the current members of staff from scratch, purchase the company assets again and create a customer base from nothing in the current market. This is what a potential buyer would have to fork out if they were to not buy your business but to start from nothing themselves.

Method 4 – Industry standard

Most industries will have a generally accepted way of calculating the value of businesses operating within that market. Using the industry standard method is not necessarily fool proof, but it will give you an easy point of comparison against competitors in the market.

The reality of business valuations

It’s a good idea to use several different methods of valuation. In theory, each of the methods you use should come out to a similar value, but in practice the results can differ massively. If you end up with a reasonable consensus between your different methods then there is a good chance that you will have an accurate assessment of the value of your business.

And significantly, unless there are a lot of buyers for your type of business, it may be that none of these methods are particularly useful aside from as a rough guide to conventional value.

In reality, your business is only ‘worth’ what a buyer is willing to pay – and this will fluctuate depending on a wide variety of variables, including the underlying health of the economy, industry-specific trends, and so on.

If you do end up with a set of valuations which differ wildly, it is a good idea to ask your accountant to help you come to a value you can stand by.