4 methods to value a business you should consider

Business appraisals are not an off-the-shelf exercise. There are different valuation models employed by business owners, acquirors, intermediaries, and appraisal professionals based on the industry of the business, size, profitability, type of business, and use of valuation—sale, merger, investment, divorce, or litigation.  

Understanding the Method to value a business and how it functions can give you the power to make smart decisions, whether you’re buying, selling, or simply making an informed estimate about your business’s destiny. 

Valuations are usually performed by one of the four main techniques: 

• Asset Valuation Technique 
• Capitalized Future Earnings Technique 
• Earnings Multiple Technique 
• Comparable Sales Technique 

Now let us move on to these methods to value a business and understand how one of them can be used best in your situation. 

1. Asset Valuation Technique: Understanding The Net Value Of Tangible Assets 

The asset valuation approach approximates a company’s worth by approximating the value of all of its tangible and intangible assets and subtracting liabilities.  

The method to value a business functions best on asset-heavy companies, such as manufacturing companies, real property companies, or companies that carry heavy inventories and machinery. 

1. How It Works: 

• Assets are cash, inventory, accounts receivable, equipment, vehicles, land, and intellectual properties (patents, trademarks, etc.). 
• Liabilities consist of debts, loans, bills payable, and other obligations. The equation is: 

Business Value = Total Assets – Total Liabilities 

The thus-calculated value is called Net Asset Value (NAV). 

2. Consideration Of Goodwill: 

Goodwill in reputation, customer base, and a good location is a valuable asset for a company, especially when the company is as old as centuries.  

But under the asset approach to valuation, goodwill is not usually permitted except as a type of accounting within the books.  

This makes the asset approach more conservative and appropriate in companies where the goodwill cannot be transferred, distressed companies, liquidation, etc. 

• Where the company is being valued for liquidation or bankruptcy 
• Where the company is newly established and yet to gain profits 
• In highly asset-based and low-goodwill companies 

2. Capitalized Future Earnings Method: Profitability And Return On Investment 

The most common technique of valuing small and medium-sized enterprises is the capitalized future profits approach.  

It relies on the ability of the business to earn future profits, which are capitalized in order to find out its value at the current moment. 

1. Why It Matters: 

Fixed assets are not being acquired by business acquirers—business acquirers are buying future profits the business will generate. This method to value a business in the present time by approximating the corporation’s future returns. 

2. How To Calculate: 

1. Gather average net profit for the past 2–3 years, smoothing out owner compensation, abnormal expenses, and sundry costs. 
2. Choose a suitable rate of capitalization (ROI), or rate of return you would expect an acquirer to pay. The lower the rate, the greater the valuation, and vice versa. 
3. Apply the formula: Value = Average Annual Profit / ROI 

Example: 

The average net profit of the business is $100,000, and you would expect a 25% return, the value is: $100,000 / 0.25 = $400,000 

3. When To Use: 

• Single proprietorship or service operations 
• Where value drivers are basically profitability and goodwill 
• Where future profits are known and certain, and relatively so 

3. Earnings Multiple Method: Industry Comparisons 

The multiple earnings method is theoretically equivalent to the capitalized earnings method but uses Earnings Before Interest and Tax (EBIT) or Earnings Before Interest, Tax, Depreciation, and Amortisation (EBITDA) multiples in a multiple industry (a multiple) to derive business value. 

1. How It Works: 

• Step 1: Estimate EBIT or EBITDA 
• Step 2: By a multiple, typically between 1.5 and 6, based on industry, size, growth potential, and risk profile 
• Step 3: Your EBIT divided by your selected multiple 

Example: Let’s say your EBIT is $200,000 and your multiple is 3, then your business value would be: $200,000 × 3 = $600,000 

2. Key Determinants Of The Multiple: 

• Market conditions and demand 
• Industry growth rate 
• Size of the company and customer 
• Competitive position and recurring revenues 

3. When To Use: 

• When comparing a group of companies within the same industry 
• If industry benchmarking figures are available 
• For stable companies that have established revenues 

4. Comparable Sales Method: Benchmarking Against The Market 

Comparable sales method, or market method, estimates your business value through recent sales data of similar businesses. Brokers and real estate agents commonly use it as it is the recent actual sale price and the degree of demand in the market. 

1. How It Works: 

• Gather recent comparable business sale data in your region and business 
• Relative to profitability, size, and other operational differences 
• Establish a rational selling range consistent with such information in the marketplace 

Example: If other similar cafés in the vicinity were selling last month between $250,000 and $300,000 and yours is seeing better traffic and a newer plant, you can sell it at the upper end of such a range. 

2. Challenges: 

• Harder to locate wrong, old, and extraneous data 
• Requires accommodation for special features or idiosyncrasies 
• Less accurate in specialist markets 

3. When To Use: 

• For business and hospitality companies to use 
• When there is some recent available sales data and relevant 
• When determining a business value to sell or negotiate 

How To Choose The Best Method For Your Business 

The best method to use depends on several factors: 

As a precautionary measure, in the event you are unsure which approach will best serve you, an expert business broker or professional valuer can guide you through market data and facts-based valuation.

Contact Sydney Expert Business Brokers 

Determining the worth of a business is half science, half art. Math and equations are involved, but experience, knowledge of the industry, and negotiating skills are also required. That is where a professional business broker will come in handy. 

Lloyds Business Brokers in Sydney have assisted numerous business owners and purchasers with the valuation and sale process.  

Whether selling your business, preparing for an exit, or interested in investing in a new business, Lloyds can get your valuation accurate, realistic, and market-focused. 

Empower Method To Value A Business Decision With The Right Valuation  

Understanding how a business is valued is valuable if you’re buying, selling, expanding, or raising capital.  

Every technique has worth: asset-based, earnings-based, or market-based. It just becomes a question of using the technique to your company size, industry, and strategic plan. 

Speak with seasoned experts to understand how best to offer your company’s worth in the current competitive market.  

Well-documented valuation not only maximizes your compensation but also earns buyers’, lenders’, and investors’ confidence.  Get an idea of your business’s worth. Call Lloyds Brokers in Sydney and step forward to the next level in your business life.