It’s important to know what your company is worth, even if you aren’t planning to put it up for sale. There’s no one standard formula to determine the value of your business, but financial experts say there are established ways to calculate a logical estimate. “Methods for valuing a business can include asset-based valuations, valuations based on future cash flows, and book value,” says Allena Price, a CPA in Sacramento, California. Here are some important points about each method:
Asset-based valuations
“This is when you take a look at the physical assets of your business and put a reasonable market value on them,” says Marquita Trenier Wiley, president of Trenier Enterprises, a business broker company in Belleville, Illinois. “You determine what it would cost to buy the fixed assets of your company, and that’s the value to begin with.”
The book value is another asset-based valuation. “This is the accounting value calculated by subtracting total liabilities from total assets,” Trenier Wiley says.
Asset-based methods are often more appropriate for retail and manufacturing companies, because they have tangible assets such as equipment, inventory or real estate that can be quantified.
Several companies don’t have substantial tangible assets, however, so these valuations could minimize their worth. “Many of the assets of a service business [such as goodwill and client lists] may not be recorded in financial statements,” Price says. Instead, these companies could calculate a value based on their revenues or cash-flows.
Valuations based on future cash flows
An example of a revenue-valuation method would be the owner’s discretionary cash flow. It is calculated by taking the company’s earnings before interest, taxes, depreciation and amortization are subtracted, and adding in the cost of the owner’s salary and any benefits, Trenier Wiley says. “In doing this, you come up with a way of valuing the profit or the cash flow from the business,” she says. In addition to being a way to value a company with intangible assets, this method also helps value a company that’s profitable and has a good future outlook.
There are also several rule of thumb calculations that combine asset-based and cash flow valuations. For example, multiplying “three
times the average earnings for the last three years,” or “two times the book value,” are examples of rule of thumb calculations. They’re often too simple to use for real transactions, but they could give owners a general sense of their company’s worth.Transaction Costs
If you’re selling your business, a potential buyer would also consider his or her costs for acquiring your concern in addition to its value. “They’d need to know how much money they’d have to put into the company versus what they’d have to borrow, and they’d ask themselves if the cash flow was enough to service any debt,” Trenier Wiley says. If their transaction costs were too high, they’d make adjustments on the value of your company, which could result in a lower offer to you.
Real estate could be another concern. “If the business owner also owns their building, and they’ve been in it for a long time, it’s often hard to sell the business with the real estate included. That’s because the company may not produce enough cash flow to cover the cost of the appreciated real estate,” Trenier Wiley says. “What I would do then is have the owner retain the real estate and lease it back to the new owner.”
It’s important to know the different methods for calculating your company’s worth. “Depending upon the one chosen, the value of the business can change significantly,” Price says.