As a business owner, it's easy to assume that the valuation of a company is based solely on the balance sheet or the sum of your assets instead of taking into consideration market conditions and future income. When this happens during a negotiation, it can dramatically impact how much you get out of the deal. Before you assume you know the answer to the question, "What is my business worth", take a look at what company valuation specialists look at when performing business appraisals.
What is my business worth? The answer may surprise you
Asset-Based Approach
An asset-based calculation of business value is one of the most commonly used methods by business owners, but it's also the least accurate. Many business owners will look at the depreciated value of their assets on a balance sheet as compared to their liabilities and think their business is worth the difference. Unfortunately, many businesses depreciate their capital equipment based on a standardized rate schedule developed by the IRS instead of basing the value on what the equipment is actually worth. This can create a significant difference between what a business is worth on paper versus in reality. First, appraisals should be completed on the assets for the analysis to be accurate. Second, if the business is profitable, more likely than not the business has created goodwill and this method does not take it into account.
Income-Based Approach
By comparison, a business appraiser will look at one of two other approaches long before they look at an asset-based approach. The first of these is an income-based approach, which calculates the value of a business based on prospective future earnings. The business value is based on a projection of income for a certain time period, which is then discounted for a business value. When a company demonstrates that it has regular growth and cash flow, the appraiser will use a capitalization of earnings method to project potential income into the future. If the company has had irregular cash flow and periods of boom and bust cycles, a discounted earnings method is used to project the income into the future, providing a current price for the expected future benefits.
Market-Based Approach
The other approach that a business appraiser may choose to take, based on the circumstances, is to look at what similar companies are selling for to determine a fair value for a business. This can be based on information available for transactions that occurred for similar businesses. For example, discretionary earnings is calculated by adjusting financial statements to calculate an adjusted EBITDA which includes the owner's compensation, which is then calculated with a multiple to determine value. Other methods look at a percentage of the company's revenue. Statistics is used to develop multiples and percentages and they are applied to the subject business.
Now that you have a better idea of what a business appraisal specialist sees when performing valuations, what answer do you want to the question, "What is my business worth?" By having a quality company appraisal performed by a certified business valuation specialist, you can ensure that when you leave the negotiating table, you've done everything you can to ensure you get what your business is really worth.