Business valuation is the activity of professionals in the systematic collection and analysis of data necessary to determine the value of enterprises, and types of business (any type of activity or equity participation in it), based on current legislation and standards.
The price of an asset is indirectly affected by several factors that can be managed to maximize the value of the business.
Sooner or later, business owners, their partners, or subordinates ask themselves the question: “How do value an investment business?”
At the same time, few people think that the value of the business can be maximized by competently managing its valuation. So, if you want to know how to value your business – read this article.
How to value a business for investment
Here are the most commonly used methods of market value assessment that an entrepreneur-seller may encounter:
- By costs incurred.
The basis of this approach is the belief that the same business can be created by others in a comparable time frame and at comparable costs. If the entrepreneur agrees to this, the question arises: how much did it cost to create and develop the company until now?
- By the total value of assets
This method is especially good for owners of large tangible assets: real estate, mines, tunnels, wells, and production facilities. At the same time, this method often gives distorted or unreasonable estimates of the value of businesses that actively work with intangible assets or are engaged in innovation.
- By industry analogs
This method uses information on the purchase/sale of similar companies. The method is simple and generally logical: if similar companies (or stakes in them) were sold at such prices, then why not take their average value as a fair estimate, adapt this estimate to a specific business with the help of simple coefficients that take into account the scale and specifics.
- By cash flow forecast
This method is most suitable for the valuation of the company taking into account the prospects of its development. To build a valuation using this method, it is necessary to have a reasonable and credible financial forecast for 5 years ahead.
The fair market value of business how to determine
The value of an online business for sale, a division, or a separate asset is determined on a fixed date and consists of two basic components:
- Fair value of non-current assets (tangible and intangible).
- Working capital.
Specialists will help you sell your business online view website.
Tangible assets are easy to evaluate: usually, they are physically available assets with a final (liquidation) value. For their valuation, the cost and comparative approaches are most often used.
The first is aimed at determining the cost of reproduction of the asset. In other words, how much money should be invested to build the same (or as similar as possible) asset from scratch minus depreciation?
Assets valued under the cost approach are usually additionally tested for economic depreciation.
The comparative approach is a comparison of the price of the object of valuation with the price of a similar asset on the market. For example, if you need to evaluate a plot of land near Lviv, the data on transactions that are as close as possible to the date of valuation are used.
As for intangible assets, the lack of physical form and the possibility of their quick conversion into cash complicate the valuation process.
At the same time, over the past decades, intangible assets have taken a significant share in the structure of the company’s value.
How to evaluate the worth of a business: the formula
This formula is applied if it is clear that in the forecast period the company’s income will remain at the current level and will not grow. The market value of the business is calculated by the formula:
- V = D/R,
- where D is the net annual profit of the business,
- R – capitalization ratio.
If the company is not capital-intensive, this method gives an understanding of how to determine the value of a business. If the company’s income is growing, it is necessary to use adjustment factors about the discount factor.
How to value a business: common mistakes
Financiers and professional appraisers often didn’t know how to value a new business for investors. This is due to the unstable market situation and the development of new business areas.
The problems of how is a business valued can be divided into three large groups:
- Errors in choosing the approach to determining the value;
- Errors in the use of specific valuation methods;
- Errors in financial modeling.
We offer some simple tips to avoid mistakes:
- You need to analyze! You need to dive deep into the existing business, find a graph of all relationships and build a logical interpretation of the results.
- Ask for decoding! The reliability of the assessment results largely depends on the completeness and quality of the information.
- Consult! Hold discussions and consultations on emerging issues with the top management of the company.
- Only high-quality analysis! Pay attention to off-balance sheet assets, the level of working capital, the value of the research company – the company’s reputation.
- Assess the situation. Consider competitors, suppliers, consumers, and everything that can affect the creation of cash flow.
Goals pursued
Business valuation and its value largely depend on the goals pursued. Every day there is more and more information available, and everyone can independently assess the value of the business.
However, if you want to know how much does business cost we recommend contacting professionals to achieve quality results, especially if the business is being evaluated before selling, buying, or dividing.
