Business valuations: how to value your company

Do you know what your business is worth?

That’s what business valuations are for. An essential component for any business owner, a valuation helps you understand the true value of your company – whether you’re planning to sell your business, attract investors or set long term goals.

With a clear picture of this value, you can make informed decisions, negotiate better deals and confidently plan for the future. In this article, we’ll explore what goes into a business valuation, plus proven methods to help you confidently assess your company’s worth.

What is a business valuation?

A business valuation is the process of determining a company’s value. It considers several factors, including asset inventory, cash flow, market conditions and the company’s overall financial performance.

Business valuation is important because it provides a clear understanding of what your company is worth. It also ensures fair pricing in transactions, helps track your business’s growth and supports strategic planning for future goals.

When should you value your business?

Valuing a business is essential in several situations where you’ll need to know the company’s worth. That being said, you shouldn’t value your business at every small turn, as it’s a time-consuming process that can cause unnecessary stress and distract you from important operations.

Here are common scenarios where business valuation is needed:

• Buying or selling a business: knowing the value of your business helps determine a fair price and ensures both parties understand the company’s worth, in turn minimising the possibility of disputes.
• Raising capital: when looking for investors or business loans, a well-documented valuation will show your business’s financial health and growth potential, helping to attract better deals.
• Seeking partnership: a business valuation is often needed when navigating a joint venture as knowing a company’s worth will help you negotiate terms confidently and attract the right partners who align with your vision and mission.
• Resolving disputes or partnership changes: in cases of conflict with partners or when someone wants to exit the business, a valuation provides an objective basis for resolving disagreements and ensuring better teamwork in the future.
• Preparing for retirement or exit: if you’re thinking about retiring or moving on to new ventures, understanding your business’s value will help to ensure a smooth transaction or sale.
• Planning for future leadership: a business valuation is essential for succession planning, such as passing your business to the next generation or family member, as it ensures a fair distribution of assets (and family harmony if you’re keeping ownership close to home).
• Facing unexpected life events: life can be unpredictable, and unforeseen events such as health issues or personal emergencies may require you to reassess your business’s worth for financial planning.
• Assessing growth and achievements: valuing your business at key milestones can be a motivating way to celebrate your achievements and acknowledge the progress you’ve made.

Business valuation methods

There are several methods to choose from to determine the value of your business. Some methods focus on tangible assets, while others consider the company’s future earnings and market potential. The right method for you depends on the type of business you have, the industry you’re in and what you want to achieve with the valuation.

Here are the most common business valuation methods, and how they can help you assess your company’s worth.

Asset-based valuation

Asset-based valuation is a method used to determine a company’s value based on the worth of its assets. This includes tangible assets like real estate, equipment and inventory, as well as intangible assets like patents, trademarks and copyrights.

The total value of assets is calculated, and then any outstanding liabilities or debts are subtracted from it. The two main approaches to asset-value valuation are:

• Book value method: uses the value of assets and liabilities as they appear on the company’s balance sheet. It’s straightforward, but it might not reflect the current market value.
• Liquidation value method: estimates the net value of assets if the company were to sell them quickly, often at discounted prices. This is commonly used for businesses in distress.

Overall, this method is particularly useful for asset-heavy businesses, such as real estate or manufacturing. However, it may not be suitable for companies with significant intangible assets, such as technology and branding, as it may not fully capture their potential future earnings or growth prospects.

Formula: Net asset value = total value of tangible assets – total liabilities

Income-based valuation

Income-based valuation focuses on the company’s earnings and cash flow to determine its value. This method is particularly relevant for businesses that generate consistent cash flows, such as service-oriented companies or those in stable industries.

There are two main approaches to the income-based valuation method – capitalisation of earnings and discounted cash flow (DCF).

Capitalisation of earnings

Capitalisation of earnings involves estimating the company’s future earnings and dividing them by a capitalisation rate to determine its value. A common starting point for calculating future earnings is EBITDA, as it represents the core operational profitability before interest, taxes, depreciation and amortisation are considered – making it a useful metric for assessing a company’s ability to generate profits from its core operations, without the influence of financial decisions or accounting adjustments.

Formula: Company value = EBITDA x multiple of capitalisation rate

You can also calculate discretionary earnings. These are a subset of the company’s profits, calculated by removing non-essential expenses from the total profit to get a clearer picture of the cash available for the owner to use as they see fit. 

Formula: Discretionary earnings = pre-tax profit – non-essential expenses

Discounted cash flow (DCF)

Discounted cash flow (DCF) is a way to figure out how much a company might be worth in the future. It works by predicting its cash flow and then adjusting that for today’s value using a discount rate, which is often based on the company’s cost of capital or required rate of return.

By using this method, a business can calculate the present value of all future cash flows, taking into consideration the “time value” of money. This method helps venture capitalists, business owners and angel investors make smart decisions about how much a company is really worth, considering both its potential and the time it takes to get there.

Comparable analysis

This method involves figuring out how much a business is worth by comparing it to other relevant companies. Put simply, you look at businesses in the same industry with similar sizes, earnings, or other characteristics, and see how they’re valued. From there, you can take the price or value of similar companies and use that to estimate your business’s worth.

For example, if other companies are valued at five times their earnings, you can apply that same multiple to your earnings to get an estimate of what it might be worth.

While comparable analysis is a fast way to get an estimate of a company’s value, it doesn’t work for businesses with little or no comparable companies. Moreover, if the market is overvalued or undervalued, it can affect the results, meaning the valuation might not be accurate.

What can affect your company’s valuation?

Figuring out how much your business is worth isn’t just about numbers on paper – it’s influenced by a lot of different things. What’s important is to understand these factors and how to manage them, so you can improve your company’s value and make it more appealing to investors, buyers or potential partners.

Assets

The conditions of your company’s assets can impact its value. If you have a lot of outdated or old assets, it could bring the value down. However, you can fix this by selling or upgrading them, or even by replacing them with more modern, efficient equipment. 

You can also focus on boosting the value of your intangible assets like patents, trademarks and intellectual property. Securing intellectual property rights and investing in branding or marketing can increase the perceived worth of your business.

Earnings

Earnings are a big deal when it comes to your business valuation. If your company is seeing lower profits or inconsistent earnings, that could hurt your value. However, if you’re able to boost your profits, it can definitely help.

Take a look at your pricing strategies, reduce costs where possible, make sure you’re chasing overdue invoices and keep your finances in check. Showing a track record of strong, steady earnings growth will make your business much more appealing to potential investors or buyers.

Growth prospects

Your company’s growth potential is key to its valuation. If you don’t have a clear plan for growth or your industry doesn’t have much room for expansion, that can hold your value back. On the other hand, if you explore new markets, products or services, you can prove that your business has room to grow.

Make sure you have a solid, well-thought-out growth plan that’s backed by market research and shows what makes your business stand out. If necessary, rebranding your business could help rejuvenate excitement and attract more customers.

Risk

There’s always some level of risk in business. Things like economic downturns, changes in regulations or relying too much on one target market can bring down your company’s value. But by spotting these risks early and coming up with strategies to reduce their impact, you’ll be better prepared.

A strong risk management plan that includes factors like customer retention, loyalty programmes and a more diversified business model will help show investors and buyers that your business is less vulnerable to external threats.

Market conditions

Market conditions, especially during tough times like economic downturns, can affect the value of your business. For example, the cost of living crisis has hurt many businesses in the last year. While you can’t control these outside factors, you can still take steps to prepare for them.

Having a business continuity plan in place and setting up a “survival mode” strategy can help your company weather any rough patches. Investors will appreciate that you’re ready to handle whatever comes your way.

Summary: Boosting and reducing factors to business valuation

How to secure a good business valuation

A good business valuation is essential for attracting your investors, selling your business or just assessing its current worth. To ensure you get an accurate and favourable valuation, it’s important to take a strategic approach. Here are some key steps you can take:

Have a solid business plan

Your business plan should clearly outline your vision, mission and strategies for achieving long term success. Make sure to include detailed financial projections for the next 3-5 years, covering revenue, expenses and profitability. This will also help you demonstrate how you’ll manage risks, respond to market trends and position yourself for growth, making your business more attractive to investors.

Update your financial statements

Ensure your financial statements, including your balance sheet, income statement and cash flow statement, are accurate and reflect your company’s true performance. Clean, well-organised records are essential for the valuation process because investors will use these documents to assess profitability, liquidity and financial stability. It also shows that you have good financial management practices.

Minimise risks

Identify any potential risks your business may face, such as economic downturns, legal issues or over-reliance on a single target market. You should take proactive steps to mitigate these risks, whether through diversifying your customer base, obtaining insurance or building a strong risk management framework. A company with a clear strategy for reducing risks will be valued more favourably, as it signals stability and long term viability.

Highlight growth opportunities

Make sure to show potential investors where your business can grow. This could be through launching new products, entering new markets or finding ways to work smarter and more efficiently. If your business has a lot of room to expand and clear plans for growth, it’ll likely be worth more because it shows there’s potential for more profits down the line.

Showcase unique assets

This means pointing out any special or valuable assets your business has, like intellectual property (patents, trademarks, copyrights), unique technology or a strong brand. These intangible assets can significantly boost your business’s value, especially if they give you a competitive advantage or are hard for others to copy.

Consult with experts

Remember to get help when you need it, such as from business valuators, accountants, or financial advisors who know the best ways to value your business. They can help ensure that you’re using the right method and that your company is positioned favourably. Moreover, they can give advice on areas you can improve and make your business more appealing to investors.

Conclusion

In the end, a solid business valuation is a vital asset that every business should wholeheartedly adopt.

It’s all about being proactive by organising your finances, showcasing what makes your business stand out and emphasising its growth potential. That way, you can make sure your company is seen in the best light.

Whether you’re planning to sell, bring in investors or just get a better sense of your business’s worth, a little preparation goes a long way in securing a valuation that reflects the true value of all your hard work.