A guide to valuing a business

Determining the true business value is tough. There is no one way to value it and a wrong business evaluation can cause financial losses to the buyer. In this article, you will learn how you can value a business.

Pre-valuation checklist

1. Why is the seller selling a business? Is it because his products are priced higher than the competition? Are they of inferior quality? Is his technology obsolete? Do his products have no marketability worth? 2. Are economic conditions ripe to make the buy? Or, will there be a period of waiting before business picks up? Caution needs to be exercised during tough economic times. 3. What is the market value of the firm’s assets? Are they obsolete? Are they in working condition? 4. How many customers does the firm have? Does it rely on a few customers or on a wide customer base? 5. Does the firm have a brand value? Are its intangible assets worth anything? 6. Is the price realistic? Can the buyer arrange for funds without getting over committed? 7. Does the business have potential?

Valuation techniques

Entry cost One of the strong business valuation methods. It takes into account the cost of setting up a similar business. Then it adds the cost of creating a customer base, hiring staff and training them and the market value of intangible assets (eg, goodwill valuation). The sum is compared with what the seller is quoting. Discounted cash flow The net cash (revenue less expenses) which can be collected by the selling company over a period of time is estimated. This is then discounted to arrive at the “terminal value.” For example, if a business expects to generate £50,000 for the next 5 years, then the buyer can discount it at 6% per annum and arrive at the price. Industry valuations Sometimes the going rate of a business is set by the market. If such companies are bought and sold very often, then folks in the industry typically know how the company evaluates without getting into complicated calculations. Earnings multiples This method works for well-organised companies. The market price of the company’s stock is divided by the earnings per share to arrive at the earnings multiple, also known as the P/E ratio (Price/Earnings). A fair P/E that is applicable for similar industries is used to calculate the selling price. To sum up Valuing a small business for sale needs a professional valuator. He can check the audit fundamentals and even get the buying business a discount. Large and small business appraisal is best left to professionals and buyers must not attempt to self-evaluate using theoretical company valuation methods.