The reasons for valuing a business are many and varied. The occasions when this is needed are when you are buying a business, selling a business, selling a share in a business, getting a business loan, attracting investors or valuing your own net worth.
There are many ways to value a business and some are more difficult and complex than others. Also, each method will have its pros and cons which is way most valuations use a combination of methods.
The buying and selling of businesses is often a lengthy negotiated process and because buyer and seller both can have vastly different opinions as to what is a business is worth. Here is where a good valuer like a business broker or as accredited professional valuer is worth their weight in gold. A well prepared, balanced and independent business valuation can vastly speed up the negotiation process and also engender the high level of trust required for the transaction to take place.
Ultimately, a business is only worth as much as what the other party is willing to pay and one good starting point is to benchmark what other similar businesses were changed hands for. This market price indication is usually a sufficient starting point for both buyer and seller to determine if further detail is required and also if negotiations should be taken to the next level.
Whilst valuations are based on a combination of methods, the two most common valuation methods are a valuation based on net worth (i. e. assets and cash holdings minus liabilities) and the other, is a valuation based on annual net profit and an expected rate of return on investment (ROI).
The former, which is based on calculating net worth is arguably the easiest way to value a business. As it is simply the difference between what the business owns and what the business owes, it can be a relatively straight forward process. The difficulty here arises when there are intangible assets mixed in with the tangible assets. Intangible assets include things like goodwill and intellectual property. Tangible assets are the things like machinery and equipment. Sometimes intangible assets can be hard to value and this method really doesn’t take into an strong growth likely to be experienced in the coming months.
The latter, which is valuing a business based on its earning capability. A general rule of three times the annual net profit is a indication of how much the business is worth (based on secured income). This however does not take into account factors such as an increasing or decreasing market.
As highlighted, mostly a combination of the two or more methods are used to determine the value of a business and it is up the both parties to eventually agree on the actual figure.