- Elon Musk, Investor & Entrepreneur
In order to sell your business at a fair price to both you and the potential buyer, it is important to know the value of the business beforehand. You can calculate the value of the business with a business valuation.
With a business valuation, you and potential buyers will have a clear idea of the assets, liabilities, and debts that affect the value of your business. From these calculations, you and the potential buyer will be able to better negotiate the price and terms of your business. Read on to find out more about business valuations.
WHAT IS A BUSINESS VALUATION?
A business valuation is sort of like an appraisal for your business. It is a way to assess the worth of your business in terms of assets, liabilities, and debt. Valuations are done by calculating a business’s tangible assets (land), intangible assets (trademarks), liabilities, and debts. Together, these factors show how profitable the business is on a yearly basis.
WHY DO I NEED A BUSINESS VALUATION?
There are many instances why you would need a business valuation. Most obviously, you will need a business valuation if you are looking to sell your business. This valuation will tell potential buyers how profitable the business already is and will help you all agree upon a payment price for the business. Without a business valuation, it will be difficult to settle on a fair price and sell your business.
More so, a business valuation will help you to settle disputes within the law or company. For example, a business valuation will come in handy if you are in the midst of a divorce. It will also be a good idea to have a business valuation whenever you are obtaining a loan or changing ownership.
DO I NEED TO HIRE A PROFESSIONAL?
Unless you are conducting a business valuation simply out of curiosity as the business owner, you should always hire a professional to conduct your business valuation. This ensures that the valuation is conducted properly and that the valuation will be trusted by all parties involved.
As the business owner, potential buyers or other people may consider a self-conducted business valuation biased or flawed. So, it is important to hire a professional to conduct your business valuation if you are trying to sell your business, go through divorce proceedings, interact with the IRS, or anything else that involves another party.
Of course, hiring a professional to determine the valuation of your business will cost money. The final bill will depend on the length and comprehensiveness of the project. On average, hiring a professional can cost anywhere from $5,000 to $20,000.
If you are simply interested in the value of your company and do not plan to sell it any time soon, then you can conduct your own informal business valuation. This may help you to learn if you need to cut costs or focus on a specific project. If you conduct your own business valuation though, it will not be considered a valuable or trusted business valuation and should not be pitched to other parties.
HOW TO DETERMINE YOUR BUSINESS VALUATION
There are several ways that you can determine your business valuation. The size of your business, number of employees, and expected growth are all factors that affect how a business valuation is determined.
For small businesses, you will want to remember your seller’s discretionary earnings (SDE). The SDE will tell you the business’s income before paying the owner. In contrast, larger businesses will need to use the metric of earnings before interest, depreciation and amortization (EBITDA).
With that in mind, here are the best ways to determine your business’s valuation:
1. ASSET-BASED VALUATION
The asset-based valuation calculates your business is worth based on its assets. This means you will look at the company’s balance sheet, rate the value of all tangible and intangible assets, and subtract from the asset total in the case that there are liabilities. You could also sell off the company’s assets and then pay off the remaining liabilities to calculate the valuation.
2. HISTORICAL EARNINGS-BASED VALUATION
You can look at your business’s gross income to determine its value. If your business is consistently in the green, it will have a higher valuation rate. In contrast, your business value will decrease if it frequently is failing to generate consistent income.
3. MARKET VALUE-BASED VALUATION
You could also determine your business is worth by comparing your business to a similar business that has recently been sold. This is done in order to find a fair market value for your business. This valuation technique is only valuable if there’s a decent number of comparable businesses in the area. This technique may be good for you if your business operates in a crowded field of similar businesses.
4. RELATIVE VALUATION
Relative valuation determines your company’s worth by determining how much money the company would bring in if it were sold. In this valuation technique, you compare the company’s assets to other similar assets. This gives you an estimate for price negotiations.
5. DISCOUNTED CASH FLOW VALUATION
If your cash flow is not consistent, you may want to use a discounted cash flow valuation. With this method, you calculate future net cash flow and then adjust it to present values. This strategy will help you to determine how much your business assets will be worth at a future point.
A business valuation is a great way to know the value of your business in terms of assets, liabilities, and debts. Having a professional business valuation is the best strategy for striking fair deals on your business and changing ownership.
Depending on your business model, there are different methods of business valuation. Each valuation type will offer a comprehensive look at the value of your business and will serve as an accurate portrayal of its profitability. Simply research which method is best for your company and hire a professional to conduct the valuation.
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