How To Valuate A Small Business?

How To Valuate A Small Business? Why Is Business Valuation Necessary For Every Kind Of Business Out There?

Small Business 5 Mins Read December 20, 2023 Posted by upasana sarbajna

Knowing the value of a business is not just important for bigger organizations. It is equally important for people to know how to valuate a small business as well. Business valuation may be helpful in creating more effective and accurate business goals and is extremely necessary if you are looking to sell your business.

However, the process of business valuation is not easy. There are a number of processes that businessmen have to go through in order to evaluate their small businesses.

In this article, we shall discuss everything on how to valuate your small business. By going through it, you may be able to find out the value of your business and how you would improve the overall valuation of your company.

How To Valuate A Small Business 

While you are quite pleased with your results, the value of your business is not a vanity metric. A full-fledged small business valuation may be important if you are planning to sell your business. Business evaluation is also important if you are planning to merge, buy out all the other owners, apply for a business loan, offer the employees equity, or if you are going through any life-changing event.

However, there are multiple ways in which you may be able to value your small business. The appropriate method may depend on the size of the business and for what purpose you are doing the valuation. Having an understanding of all the general methods and why the outcomes differ may be quite important for everyone who owns a small business or owners of bigger corporations.

Why Do You Need To Valuate Your Business? 

Why Do You Need To Value Your Business

There are multiple reasons as to why you would want to value your business. These reasons may include the following:

  • When the business is up for selling
  • If you are trying to find more investors
  • When you are planning to sell stocks in the company
  • When you need a bank loan against your business

For you to have a full understanding of the growth of your business.

The most general reasons as to why one would want to value their business are sales and investment purposes. Valuing the business means you may be able to tell the investor, buyer, stakeholder, or banker the exact worth of the business. This way, you will be able to hold ground over how much you are willing to sell and how much they would have to work for it.

Business valuation is extremely important when you are presenting it to buyers or investors. It is evidence of the actual worth of the company. This is one of the best ways to get the attention of investors. If you are not able to demonstrate to the investors the worth of your business, they will not have any solid reason for investing in your business.

How To Valuate A Small Business: Methods Of Business Valuation 

There are multiple ways in which you can easily break down the value of your business. The two most common ways in which you may be able to evaluate your business are the discounted cash flow method and the multiples method.

Let us now learn about these methods in detail:

Multiples Method

The multiples method takes into consideration all of the identical organizations for similar prices. By using this method, you would be needing yet another company in the industry that very recently got sold. Then, take all the sales prices and divide them by the total sales of the company, the earnings before interest and taxes (EBIT), or the earnings before interest, taxes, depreciation, and amortization (EBITDA).

By doing this, you will arrive at a number. This number is your multiple. Then, you would have to multiply the number by the sales of your company, EBITDA or EBIT, to reach the valuation.

Discounted Cash Flow Method 

The DCF method does not take the results of the other companies into account. Rather, it focuses on the projected cash flow of the company. You will be giving the best cash flow results for the upcoming three to five years. Then, you would be using the formula to calculate the current values of the cash flows.

The present value is the concept that compares the money to be earned in the future to how much the investor would be making in interest if they had kept the money.

It uses a rate of discount, which is likely the rate of interest that the investor would have gotten from saving the funds.

If the present value of the company is a little more in comparison to the investment amount, it would be a good investment.

When you use the cash flow of three years, this is how the formula would be:

Value = Cash flow year 1 + Cash flow year 2 + Cash flow year 3

 (1+ discount rate) (1+ discount rate)2 (1+ discount rate)3

How To Valuate A Small Business: Calculations

Here, we would be focusing a little more on the multiple methods because it is a little less complicated, and is more widely used everywhere.

Here are the four steps that may help you obtain the proper valuation of the assets:

Do Not Consider The Capital Assets When You Are Valuing Your Business 

Unless you are a professional chartered accountant or a money wizard, you may be guilty of making the mistake of associating your asset value with your business value. Keep in mind that these two are completely different entities and do not relate to one another.

Work Out Your Profitability By Being Aware Of The Gross Income And All Of The Outgoing Payments

The Only Thing That Measures Your Business Value Is Profits.

Company valuation is everything about the money you are making now and in the future. However, it is not every bit of profit that we are talking about. We are only taking into account the net profit.

Calculate The Value 

This is the one step that everyone hates. This is the actual math that is needed to calculate the value of your small business.

Factor In The Market Valuation 

The valuation is only a guide. You create a valuation that you may be able to present to the investors or the buyers, offering them a respectable and reasonable answer to the question, ?What is your business worth??

The Bottom Line 

No matter what size the business, it is important that every business knows how to valuate a small business. This way, they have a better chance to offer to the investors to fund the company or buyers to purchase it.

Business evaluation is not a one-man?s job. It needs the help of professionals. Therefore, you need to make sure that you are consulting an accountant to guide you through the process.

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Upasana is a budding journalist who has a keen interest in writing. She considers writing as therapeutic and is most confident when she writes. She is passionate about music, movies and fashion. She writes in a way that connects with the audience in a personal level. She is optimistic, fun loving and opinionated.

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