At some point in your business life deciding whether to sell your business could be one of the more important decision you could make. This may be due to health or age reasons or an opportunity to make a capital gain due to right business climate. Then having the right tools to value your business properly becomes crucial.
Alternatively you may wish to purchase an existing business then too having a good understanding on how to value a business becomes very important. Let us look at the different ways that you could value the business.
Net Asset Method
This refers to making a list of all assets in the business and then performing an adjustment on the value of those assets to arrive at the market value. Also you might opt to take the forced sale value instead – but in a going concern it is common that the market value is used instead. Now prepare a list of all the business assets and there values and add it all up and from this total deduct all the liabilities of the business. The liabilities of the business will include payables, bank loans, lease payments, tax liabilities, rates, other liabilities. There may be other contingent liabilities such as legal cases and dues to employees, retirement benefit plans etc. You need to assess the amount for these contingencies too.
Once you are able to get a figure for the total assets and deduct total liabilities and contingencies the result will be the Net Asset Value of the business.
Cashflow Method of valuation
Cash flow method of valuing the business involves making changes to the profit for the year of the business by adding back items such as depreciation, amortisation, provision for receivables, provision for retirement benefits and all other non cash items.
When the calculation for the total cash-flow is completed divide the total amount with the cost of capital for your business. Cost of capital could also be the target ROI of your business can be anywhere from 10%+ to a higher figure.
For example if a business has a total cash-flow of USD 1,000,000 and a cost of capital is 15% then the value of that business is USD 6.666Mn
Earnings Method of valuation
The earnings method of valuation is similar to the cash-flow method except in this case you need to compute the total earnings of the business instead of the total cash-flow. There may be one off items in the income statement that do not reflect the true earnings potential of the company these have to be removed from the profit for the year before attempting to value the business.
Once you have arrived at the total net earnings value for the year divide that number with the cost of capital percentage or target ROI required for your business.
For example if the total earnings of the business is USD 500,000 and your target ROI is 12% then the value of your business would be USD 4.166Mn
There are various other methods of valuing a business such as the Dividend payout method and Discounted cash-flow method that are in principle based on the latter two methods.
If are deciding to make a complex acquisition or sale of a business it may be wise to have an financial advisor undertake a due diligence of your company.
Now let us see how a business can improve business valuation by taking certain simple steps.