How to Value a Business
Your business is surely an asset and consists of a certain economic value. Most of the entrepreneurs usually lack the proper information about the business valuation stages which traditionally includes few basic components such as how to value a business, the formula of dedicating weightage to your sales and much more.
The newly established entrepreneurs hold the perception that business valuation is important during the business selling phase. It is true that business valuation help in deciding the total business worth but this step should be performed during the initial stages.So, let’s start understanding How to Value a Business.
What is Business Valuation?
Before jumping to the actual discussion, it’s important to establish the pillars of the conversation so that entrepreneurs could understand the logic behind business valuation.
Business valuation is the systematic procedure which helps in determining the overall worth of a startup based on its current asset value, overall sales weightage, and the revenues generated from the successful sales.
Traditionally the process of business valuation is divided into three major categories which are as follows:
As the name suggests, market approach is the business valuation strategy which helps in determining the worth of a business based on its fair market value.
In this method, the business owner considers the buyer-seller approach and set a price range which a potential buyer of the business might be willing to pay and a price which seller is ready to accept. The monetary value of the business is expected to fluctuate on the basis of several economic factors however, the price range can provide a good business estimation to the owner.
This approach is beneficial for those individuals who are planning to value their business while considering the prevailing competition in the market and the current entrant barriers.
The asset approach helps in determining the total business worth based on the liquidity of the business. Every business has certain assets which are further divided based on terms (short term and long term), similarly, every business also has certain liabilities which a company is supposed to pay off during the given time period.
This approach aims to extract the business value by subtracting assets from the liabilities. Asset valuation strategy can help the business owner in gaining insight about the total net business worth and economic benefits which can be extracted from the business the similar nature.
This approach also helps the owner in evaluating the cost of some of the internal assets which are normally not considered as a part of the balance sheet.
As the name implies, income approach is basically the laymen estimation procedure in which the net worth is extracted by subtracting the expenses from the revenues. This approach helps in determining the value of any business based on its profit estimation
The capitalization and discounting strategy can also provide a good estimate of the business worth in the current market and how the economic risk can be mitigated for better profitability in future.
Benefits of Business Valuation?
The scope of business valuation is not limited to reselling procedure only however, this process tends to offer vast advantages to the company owners which are as follows:
Gives your Fair Estimation about Assets
Fair estimation of your business value can help in gaining insight into the current assets in the company which further facilitates in making a lot of business decisions.
For instance, you can apply for the insurance coverage based on the value of your assets, it can help in determining the amount of reinvesting which is needed for high valuation and reselling amount of your business with profit estimation.
Helps in Acquisition Process
During the acquisition phase, the entrepreneur is supposed to display the growth rate of the business, expected asset withholdings, future profitability of the business and at what rate it tends to grow with respect to the current market trends
The proper business valuation can help you in providing right estimation about the business strategy and what steps should be taken for better mergers.
Better proposals for investors
The potential investors are always interested in the current growth of the business backed by the proper value projection. As a business seller you cannot provide the vague estimations to the investors, however, you need proper numerical figures which can help in winning the trust of the investors and the numbers can only be acquired through business valuation.
There are three basic ways through which you can easily determine the worth of your business. Although these methods are not designed to provide the most accurate results, however, it can provide the fair estimation about the on-ng market value. These methods also tend to facilitate the small business owners during the valuation stage.
How to Value a Business Based on Sales
The sales method is the oldest valuation method and many small businesses tend to employee this method for determining their overall impact in the market. In this method, the sales of the company are used as the primary parameter and are measured by considering the inventory level, total expenses, and other overhead functions.
Sales method helps in understanding the real market value of any firm because this method tends to analyze the operations of the company. There are two ways of sales valuation which are commonly practiced by the business owners.
Geographic Sales Comparison
As the sales territories of any organization are divided on the basis of its geographic distinctions, therefore, it is important to evaluate each and every territory for gaining insight about the business worth in particular area.
For estimating the business worth based on sales, the company owner can decide one sales level as the standard one. In the next step, the sales from all the areas will be compared with the standard one for calculating the business value.
- The standard sales will be treated as the estimated value of the business and all the geographic sales will be used as the parameters.
- This method can provide a good estimate of the expected business value depending on the sales of the company.
Business value estimation based on the sales of a competitor can help the business owners in getting insight into their current performance in the market and how well they are catering to the customer demands.
- Pick and select few competing startup from your industry and check their annual sales rate by evaluating their financial statements
- Start comparing their monthly or yearly sales with your own business.
- After analysis set a percentage of sales or decide a sales level in order to determine the business value.
- If the value of your business is greater than your competitor, it means you are performing better and have the overall higher business value.
The small business owners are planning to sell their business should use this method for valuation purposes.
How to Value a Business based on Revenues
The estimations based on revenues can provide a good insight to the business owners about their current market standing. In the method, the revenues of the company are determined by using the multiple factors.
The multiple factors are backed by the different economic components such as overall
attractiveness of the industry and how the firms are performing in the market. Revenue
of any company is directly connected with the industrial structure and because of the
same reason, it is important to analyze the industrial performance.
The time revenue of any company is calculated on the basis of its business quarters.
For instance, if a company or even a small business is operating for 12 months, the
company will multiply the number of revenue with the annual factor.
Example: If a company is making $100,000 revenues on yearly basis, it will multiply
100,000 x 1 (considering 1 for 12 months). Similarly, if a company is estimating its value
for 24 months then, $100,000 will be multiplied with 2.
This method helps in determining the range of the business values instead of one
definite value. Time revenue method is capable of providing the starting value to the
negotiators which will ultimately guide the owner about the price will they will be getting
for their business
How to Value a Business/Company Stocks
Stock valuation is the financial process in which company tends to evaluate the current
value of its stock and how well it is playing in the market. This valuation technique is
usually used by big companies because their shares are floating in the share market
thus providing the option of price comparison, current stock growth rate and earning on
In order to value a company’s stock, the owner is expected to gain proper insight about
the Profit and Loss statement of the company.
- Profit and Loss statement will facilitate in understanding the current stock rate
of the company and how it is floating into the market
- For earning analysis, the earning per share principle is used in which net income is analyzed.
- EPS helps us in determining the value by analyzing the Net Income available
for the common shareholders while considering the current number of
outstanding shares in the company.
- EPS method helps in determining the overall quality of the earning on the yearly basis
- The second method which most of the companies use for gaining insight about
the expected growth is called as Growth Rate Valuation.
- In this method, the financial analysts look at the past growth trends by
observing the past sales and revenues of the company.
- This method basically helps in determining the future growth of the company.
- Due to the rapid changes in the economy and continuous changes in the
market trend the results generated from the growth method are used for the
generalization purposes only and fails to provide the required estimations.
The process of business valuation is not only beneficial for small entrepreneurs,
however, big companies also need to have accurate information about their current
standing in the market and how better they are performing as compared to other firms
in the same industry.
Which method are you planning to follow for determining the worth of your business? If
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