How do I work out what my business is worth?
Preparing for a sale, attracting investment and measuring progress are just three reasons it’s useful to have an accurate and up-to-date valuation of your business.
However, as handy as a definitive figure can be, it can be incredibly difficult to determine. There are many methods of calculating the value of a business, each with its own set of complexities.
What makes a business valuable
To understand how worth is calculated, consider tangible and intangible assets of a company.
The tangibles are those which can be measured, counted or otherwise have a reasonably concrete price applied. That includes recent revenue, profit and cashflow, as well as stock levels, property, machinery and equipment, fixtures, fittings and vehicles.
The intangibles are the aspects of a business which are useful, valuable (or perhaps the opposite), but don’t have an obvious pounds and pence price tag.
Examples include the longevity of the business and its reputation, relationships with suppliers and goodwill with customers. It also includes the quality of products, services and employees, any licenses and patents the business holds, as well as the level of competition and the market’s barriers to entry, in addition to any perceived opportunities and threats in the near future.
There are a variety of methods of calculating the value of a business, for the purpose of this guide we’ll look at the four most common.
When valuing a business for sale, the buyer will have an interest in how much profit they can expect to make.
The price-to-earnings ratio takes previous post-tax profit and multiplies it by a figure usually between 5 and 10. This multiplier depends on a variety of factors, such as the size of the business, growth potential including the ability to enter new markets or introduce new products, the value of the brand, and the uniqueness of the operation. The multiplier will be reduced, for example, where an organisation is too reliant on its owner.
While a useful tool, this ratio is imperfect as it uses historical data to predict the future.
How much would it cost to start a new business and build it to the level you’re at? That’s the entry cost of your business. Useful, as a potential buyer or investor can evaluate whether it would be easier to start from scratch. But again, this method doesn’t take into account such aspects as growth potential.
Great for an established business that’s heavy on tangibles. This valuation simply calculates the total value of all assets and subtracts current liabilities. This, however, pays no heed to the intangibles, and all their associated value or cost.
Useful for valuing new, growing or service-led organisations where there are few tangibles to take into account but plenty of brand value, growth potential and so on. This calculation values a business simply as an estimation of projected future cashflows. The price a buyer will pay is usually this figure, minus a certain percentage based on the risk that the cashflow may not materialise.
Which method is best?
Each of these four methods has merits as well as drawbacks. In truth, placing a value on an organisation is an incredibly complex matter, not least the valuation of a plethora of intangibles.
While it’s possible for owners to value their own business, it is highly advisable to engage the services of an expert, especially if the value will be used in the negotiation of a sale, or try to attract equity investment. There are simple too many variables, uncertainties and what ifs for inexperienced owners to obtain a true and accurate value.
If you’d like to value your business for a sale, to attract investment or simply to inform the board, speak to a Begbies Traynor advisor for impartial advice and assistance.
Martin has nearly 20 years’ corporate finance experience specialising in advising owner managed businesses. Martin has considerable experience advising on business sales as well as management buy-outs and acquisitions across a wide range of sectors and deal sizes.