Whether you're considering a merger, selling off a division or selling your business outright, you may have questions on how to value a business. You're not alone! The process of business appraisals and company valuation is a complex topic that requires a lot of knowledge and significant experience to understand fully. Let's take a look at some different methods use to determine the valuation of a company and how it applies in your business dealings.
4 Ways Business Valuations are Calculated
- Asset Valuation: This form of business appraisal is one of the most simplistic. It looks at the value of a company's assets in the form of inventory, accounts receivable, equipment, real estate and similar assets, then subtracts the liabilities including business loans, accounts payable and similar debts. It essentially looks at what the business' value would be if it closed down that same day and everything was sold and all debts paid. It doesn't take into account the prospective sales your business could see in the future or the business loyal customers bring in, often referred to in business circles as "goodwill", only the current situation. It often creates an undervalued figure that is an absolute bare minimum of how to value a business - that is if the business is profitable.
- Capitalized of Earnings Valuation: Commonly used to determine a more realistic baseline figure for small businesses, a capitalization of earnings valuation takes into account future earnings the business is expected to accrue. It's calculated using a rate for return on investment. The business' average net profit for several years is calculated and taken into account with the rate of return expected to determine a solid valuation for that business. This is a form of the income approach.
- Discounted Cash Flow Valuation: The discounted future earnings method is the basic valuation principle that an investment in a business is worth the present value of all the future benefits it will produce for the owner. It is most appropriate when there is uneven income or cash flow present or forecasted in the company. This is also a form of the income approach.
- Comparable Sales Valuation: This method examines the prices paid for closely held companies that are engaged in a similar line of business. It is usually calculated as a multiple of earnings or percentage of sales. It is more commonly known as the Direct Market Data Method (DMDM).
All these methods are great tools for a company's particular situation, but the best person to help you determine which valuation method best fits your company is a business appraisal specialist. Because they have a pulse on the finger of the industry, they'll know which valuation method will best meet your needs.