At a certain point, every businessperson needs to know what their company is worth. Whether you are considering purchasing an existing business, selling your business, looking to attract investors, or thinking about going public, here is a look at how to approach valuing your business.
Reasons for Valuing
The two most common reasons: selling your business or someone wants to purchase it. However, other financial circumstances might require it, like a divorce or disagreement about the value of an estate. Here are three common valuation approaches:
With this model, you calculate the net value of all the assets your business owns, taking into account depreciation to determine your firm’s value. Liabilities, such as outstanding loan balances and accounts payable, should be deducted from total assets to yield a net asset value. This method works well for retail and manufacturing firms, which are considered asset-heavy.
With the income approach (also called capitalization of income), attention is on cash flow and the return on investment, and looks at current income and the ability to produce continued earnings in future years.
The capitalization method uses a capitalization rate and anticipated earnings to value the business. Different industries typically use different standard capitalization rates as a basis for valuation, with key financial and operational factors like business growth, competitive environment, management team, and earnings history impacting the rate.
This method is much like what realtors use with prospective buyers, showing sales comparisons of similar homes. For your business, you use sales figures based on industry averages as a multiplier. This makes it the most subjective of the three approaches, which can lead to to over or underestimating value.
Documenting Your Work
Prospects will expect proper documentation. When they perform due diligence before deciding to buy or invest, they will want to check the numbers that tell the financial story of your business:
- Basic financial reports
- Sales reports
- Personnel organization charts
- Job descriptions
- Production reports
- Manuals that cover plant and office operations