How do I value my business?

If you’re thinking about buying, selling or simply running a business, understanding how much the business is worth – and how it can be made more valuable - is of vital importance.

There are three basic criteria which affect valuation: The circumstances of the valuation, how tangible the assets are and how mature and stable the business is. To arrive at this figure, buyers use various valuation methods. However, it’s probably worth noting that, ultimately, the true value of a business is what someone will pay for it. Here is a snapshot of a few of the valuation techniques used:

Asset valuation
Stable, established businesses such as property or manufacturing companies with a lot of tangible assets, such as equipment and inventory, are often suited to being valued on these assets

The price earnings ratio
This can be used to value a business that is making sustainable profits. The Price / Earnings (P/E) ratio represents the value of the business divided by its post-tax profits.

As an illustration, if the multiple is, for example, four times net profit, then for a business that makes £500,000 post-tax profit, the business would be valued at £2,000,000.

However, while multiples of earnings can be used as a business valuation method, there is no standard P/E ratio figure that can be used to value every business and can vary dramatically.

Certain businesses, such as Tech start-ups, can have a higher ratio due to their high growth. Whereas, more mature high street companies, such as cafés or retail shops, will have a lower P/E ratio. As P/E ratios differ wildly, there isn’t necessarily a ‘standard’ ratio that can be used to value all businesses.

Entry cost valuation
An alternative approach to valuing your business is by reference to the cost of starting up a similar business from scratch. You need to factor in everything that got the business to where it is today – such as, start-up costs, tangible assets, product development costs, building a customer base, recruiting, and training staff. After that, you would need to think about any saving you could make when setting up and subtracting that from the figure. When you’ve taken everything into account, you’ve got your entry cost – and a valuation.

A discounted cash-flow analysis
This is based on estimating what future cash flow would be worth today. This method is better suited to mature businesses that have invested heavily with stable, predictable cash flows over many years, such as utility companies.

Industry valuation rules of thumb
Buying and selling businesses can be more common in certain industries, so those sectors may have established, standard formula, other than profit, as a guide. In retail, for example, businesses are valued on factors such as business turnover, how many customers they have and their number of outlets.

Go beyond financial formulas
Ultimately the selling price is what someone is willing to pay. Potential strategic value could be considered here, with negotiation skill playing a part, too. If the business has desirable relationships with customers or suppliers, it might be more valuable to a buyer. If the buyer doesn’t have a stable team behind them to take the business forward, a strong management team (that won’t jump ship) could also add value.

Valuing your business can help you focus on areas of improvement. If you are buying, selling or running a business, there are many things you can do to help secure a good valuation.

If you need help in understanding how much your business is worth, please feel free to give me a call.

Further Reading

You may also find the information in these articles useful for the stage of your business

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