4 Simple Steps to Valuing Your Small Business
Valuing a small business is a complex process that involves many factors. In this expanded version of the article, we will provide even more detailed information on each step of the valuation process.
Methods for Calculating Your Businesses Valuation
To find out how much your business is worth, you can use two methods: the multiples method and the discounted cash flow (DCF) method.
The Multiples Method
The multiples method means finding out how much other companies like yours have sold for and then using that to work out how much your business could be worth. You do this by finding a multiple and multiplying it by your own company’s sales or earnings.
The DCF Method
The DCF method looks at how much money your business will make in the future. You have to predict how much money you’ll make in the next few years, and then work out how much that money would be worth today. You do this by using something called the present value, which compares money you will earn in the future to money you could earn now.
To calculate your business’s value, first don’t think about the things your business owns, like buildings or vehicles. These things don’t really matter when it comes to your business’s value. What matters is how much money your business is making, and how much money it will make in the future. To work this out, you need to look at things like how much money your business earns and how much it spends. You also need to think about how long your business is likely to last, and how much it might grow or shrink in the future.
Using three years of projected cash flow, the formula is:
Value = Cash flow year 1 + Cash flow year 2 + Cash flow year 3
(1+ discount rate) (1+ discount rate)2 (1+ discount rate)3
Finally, you can use all of this information to figure out how much your business is worth. It might sound tricky, but if you keep good records and think carefully about the future of your business, you should be able to work it out!
How to Calculate Your Business’s Valuation
Step 1: Forget about how much your business’s assets are worth. Instead, focus on how much money your business is making.
Don’t count how much your business assets are worth, like your office building or trucks. That’s not the same as how much your business is worth. A buyer doesn’t care how much they can sell your things for, they care about how much money they can make from your business products and services.
Here is a typical misunderstanding:
Consider that your company has an office building worth $800,000, as well as $100,000 in supplies and products, and an $100,000 fleet of vehicles. You have capital assets totaling $1,000,000 in total, so you assume your business is worth what you would receive in cash if you sold everything right now. Even if the data shown above may be accurate, a business appraisal goes beyond that. This is just the cash value you’d receive from selling your assets, but this isn’t what your business is worth.
Step 2: Figure out how much money your business is making by looking at its profits. This means looking at how much money it’s making and how much it’s spending.
To know how much your business is worth, you need to think about how much money it makes. A person who wants to buy your business will want to know how much money they can expect to make if they take it over.
When we talk about the money your business makes, we’re not talking about every single penny you earn. We just want to know how much money you make after you’ve paid for everything you need to run the business.
But that’s not all! When we value a business, we also think about two more important things:
- Multiples: This is a way to measure how long your business is likely to keep making money. A business that’s been around for a long time and is very stable will have a high multiple. A smaller business like yours will probably have a multiple between two and ten. To figure out your multiple, you multiply your profits by the number that makes sense for your business.
- Profitability adjustments: A business might not make the same amount of money every year. When we value your business, we need to figure out how much it might grow or how much money it might lose in the future. We do this by looking at your financial records from the past, what’s going on in your market, and what your competitors are doing.
If you want your business to be worth more, you can try things like getting more customers, selling new things, buying other companies, or opening up new stores.
Step 3: Look at how much similar businesses sold for and use that to figure out a multiple. Multiply your business’s profits by this multiple to figure out its value.
To determine the value of your small business, you must perform some calculations. Firstly, deduct all the expenses from the revenue generated by your business to get the net income. Next, consider the worth of your business in comparison to similar businesses, which is referred to as the “multiple.” You can do this by examining the sales prices of comparable businesses and the stability of your own. After determining your multiple, you can calculate the value of your business.
However, there is more to consider. You must also assess the potential growth of your business in the future. Look at the historical growth of your business and your market and add 10% growth per year to your net profits for a few years to get an estimate of your business’s potential value.
It may take some time and assistance from professionals to gather all of this information, but it is crucial to determine the value of your business.
The valuation of your company is determined by four components:
- Identify your net income. Take your small business’s gross earnings and deduct all costs to get your net income. Consider, for instance, that your company earned $1,000,000 while incurring costs of $700,000 (equipment, travel, supplies and salaries). There is $300,000 left over, which would be your net income.
- Analyze multiples
As was previously indicated, the lower the multiple you might anticipate, the riskier or smaller the firm. You must acknowledge that some speculation and subjectivity are necessary in order to determine your unique multiple. The search for a defined multiple cannot be standardized, unfortunately. There are a few fundamental guidelines to remember instead:
Examine your sector. What multiples have firms similar to yours sold for in the past?
How stable has the financial history been for your company?
Can you request a greater multiple if it is stable enough?
What state will the company be in if you sell it after you leave?
Do you have any guaranteed contracts for revenue for the foreseeable future?
How big is your consumer base, and how solid are your ties with suppliers?
You must decide what you believe your multiple should be after considering your factors. Here is a quick reference:
- It is rare that a single employee-run company will get a multiple greater than three.
- Businesses with annual revenues below $500,000 frequently have a maximum of five.
- only bigger businesses with net income over $500,000
- Only larger businesses with net income of more than $500,000 may anticipate reaching a double-digit multiple.
Going back to our previous example, we said our net profit for the year is $300,000. Our costs are $700,000, which suggests that we have a sufficient number of employees. For the purposes of this example, let’s assume that we fall into the second bracket, leaving us with a number between two and five. Playing it safe, we’ll choose four, bringing our current worth to $1.2 million ($300,000 in net profit x 4x = $1,200,000). Increase the company’s worth now based on prospective expansion. Although getting this information is not difficult,
Step 4: Double-check your calculations and make sure you didn’t miss anything.
Knowing how much your business is worth is important if you want to sell it or find investors. It helps you show them how much money they can make by investing in your business.
The final step in valuing your small business is to consider other factors that may affect its value. These include:
- Assets: If your business owns valuable assets such as real estate, equipment, or inventory, these can add value to your business.
- Liabilities: If your business has outstanding debts or liabilities, these can decrease its value.
- Market demand: If there is a high demand for businesses in your industry, your business may be worth more.
- Economic conditions: Economic conditions can affect the value of your business. For example, during a recession, businesses may be worth less than during a boom.
Tips and Tricks for Valuing Your Small Business
Here are some additional tips and tricks that will help you get the most out of the valuation process:
- Keep your financial statements up to date and accurate. Your financial statements are the foundation of your business’s valuation, so it is essential to ensure that they are accurate and up to date.
- Understand your industry and market. Knowing your industry and market trends will help you make more informed decisions about your business’s worth.
- Consider all aspects of your business. When valuing your business, consider all of its assets, including tangible assets such as real estate and inventory, as well as intangible assets such as intellectual property and goodwill.
- Consult with experts. If you are unsure about any aspect of the valuation process, consider consulting with experts such as financial advisors, accountants, and business valuation professionals.
Valuing a small business is a complex process that requires careful analysis of your business’s financial statements and market trends. By following the four simple steps outlined in this article and considering additional tips and tricks, you can arrive at a fair market value for your business. Remember, it is essential to keep your financial statements up to date and accurate and to consult with experts if you are unsure about any aspect of the valuation process.