How to Value a Small Business

Do you know what your small business is worth? If you’re buying or selling your business, it’s important to nail down solid numbers with accurate valuation formulas. Factors like industry, revenue, income statements, asset valuation, cash flow and growth estimates are needed to calculate a realistic dollar figure. Small business valuation can be complex, so we’ve complied guidelines to help you get started. Be sure to consult a financial professional to guide you if needed.

 

Why Value Your Small Business?

You don’t need to value your small business to be successful. But there are several reasons you should. You may want to sell due to retirement, health, divorce, or for family reasons. Additionally, you may need to finance growth with outside funds. Potential financiers or investors will want to see that the business has sufficient worth.

Exactly how much your business is worth depends on several variables. The state of the economy can affect your bottom line and similar recently sold businesses in your area can also have an effect.

Discounted Cash Flow (DCF)

Methods to value a business can focus on past performance. However, the DCF method is based on the long-term projected future performance. The DCF method calculates the cash flow the company will produce into the future then discounts those cash flows back into today’s dollars. The more consistent and predictable your cash flows are in your business model, the higher the value of your business.

Entrepreneurial Expert Bob Adams, who has a Harvard Business School MBA, describes DCF this way:

The discounted cash flow approach is based on a concept of the value of all future earnings discounted back at the risk these earnings might not materialize.

From Investopedia, the formula for calculating DCF is as follows:

If the value arrived at through DCF analysis is higher than the current cost of the investment, the prospect may be a good one.

 

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Price the Assets

The asset valuation method calculates the net value of your business assets. In other words, if all assets were sold and debts paid, the value is reached.

Tangible and intangible assets are both included when calculating price.

  • Tangible Assets
    You can put a value on tangible assets like real estate, cash on hand, customer base and receivables.
  • Intangible Assets
    Intangible assets are non-physical goods like trademarks and patents. Reputation can also be considered.

Liquidation Value

According to Investopedia, liquidation value is the total worth of a company's physical assets when it goes out of business or if it were to go out of business. Liquidation value is determined by assets such as real estate, fixtures, equipment and inventory. Intangible assets (see definition above) are not included in a company's liquidation value.

Comparables

One of the first things every banker learns is how to do a comp analysis, or comparable company analysis. Look at a recently sold comparable company or similar businesses in your area to discover the selling price. Keep in mind that the comparable method isn’t perfect…it can lead to uneven comparisons depending on various variables.

In Conclusion - Rules of Thumb

Building your business’ value takes time and careful planning. The first step is to accurately keep track of your business records like bank statements and financial ratios. Your books show potential for risks and profits. The more organized your books are, the better chance buyers have of seeing your value. You can use small business accounting software to keep track of your company’s finances easily.

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