How to Value and Assess your Business

Two Parts:Valuing Your BusinessAssessing Your Business's Performance

Whether you are planning to sell your business or simply want to know what it's worth, there are a number of options for giving your business a monetary value. The important thing to recognize before beginning is that any eventual sale price of your business will be negotiated between you and the buyers. This means that any value you come up with from these calculations will not be set in stone. However, these calculations are useful for providing a baseline from which you can argue for your business's value.

Part 1
Valuing Your Business

  1. Image titled Value and Assess your Business Step 1
    Calculate your business's book value. Think of your business's book value as its net worth. If you sold its assets to pay off any debts or liabilities, what would you have left? Technically, your business's book value is calculated by adding up all the book value of its assets (like cash, equipment, vehicles, and buildings to name a few) and subtracting any liabilities (balances due on loans or any other money owed to anyone) and intangible assets (like goodwill and patent value). This will leave you with a book value for your business.[1]
    • Book value fails to take into considering things like future profits or intangible assets. This means that it will almost always return the lowest value among the various valuation techniques.
  2. Image titled Value and Assess your Business Step 2
    Determine your business's market value. Unlike its book value, the market value of a company relies on how investors, or potential investors, perceive the company. It is defined as the price a business would sell for on the open market. Market value can be calculated for both pubic and private companies using valuation assumptions and comparable companies.[2] For more specifics on determining market value for your company, see how to calculate the market of a company.
    • If your business is publicly-traded, you can calculate market value by finding its market capitalization. This is the total value of all of the company's stock. Find this by multiplying the current market price times the number of shares.[3]
    • For any business, you can estimate a market value similarly to how realtors value homes, by examining similar businesses that have been sold recently. Look for businesses similar in size and industry to yours that have recently been sold and use these prices as an estimate to value your own company.
    • Companies can also be valued using multiples. These essentially multiply a business metric by an industry-average multiple to determine a valuation. For example, an industry might have an average valuation of 20x earnings, meaning that companies in that industry could be estimated at 20x their profit that year.
  3. Image titled Value and Assess your Business Step 3
    Assess value using cash flows. Finance professionals use a method called discounted free cash flows analysis to value companies and other investments. This method essentially values a business by forecasting cash flows over a future period time, like the next 10 years. These cash values are adjusted (discounted) for market factors and cash outflows, then added to a terminal value that estimates cash flows outside of the ten year period.[4]
    • It goes without saying that this method is extremely complicated and can result in a wide variety of variations for your company. Unless you are a financial professional, it may be better to hire a consulting firm or bank to do this type of valuation for you.
  4. Image titled Value and Assess your Business Step 4
    Analyze intangible assets. Unlike property or cash, intangible assets are those owned by a company that cannot be physically touched. That is, they provide added value to company without physically contributing to sales. Intangibles assets include things like intellectual property (including copyrights and trademarks), goodwill (an accounting term used for a premium on the purchase of a company), and brand recognition. These can contribute significantly to the value of a business.[5]
    • While intangible assets can sometimes be held on a balance sheet, like in the case of goodwill, most are the result of an accounting judgement. This means that you can get creative and argue your case for your business's brand recognition or intellectual property value. Consider backing your argument up with market data or the value of similar intangibles in other companies.[6]

Part 2
Assessing Your Business's Performance

  1. Image titled Value and Assess your Business Step 5
    Analyze your business's profitability. The first and most obvious step in assessing your business's performance is determining how profitable it is. This information should be readily available on your income statements for the past year and years before it. The numbers you will want to examine on your income statement will depend on how you are assessing your business. The most common metric used to evaluate profitability is net income, also known as the bottom line. This represents your actual profit, after depreciation, interest expense, and taxes. For more on net income, see how to calculate net income.
    • You can also assess other types of efficiency and profitability by examining different parts of the income statement. For example, you can find manufacturing efficiency by dividing your revenue by your cost of goods sold. This lets you know how well you are converting manufacturing costs into revenue.
    • Another value that finance professional use to determine profitability is earnings before interest, taxes, depreciation, and amortization (EBITDA). This is net income with interest, taxes, depreciation, and amortization expenses added back in. This is useful for comparing your business's profitability versus other companies because it negates the effects of individual accounting and financing decisions.[7]
  2. Image titled Value and Assess your Business Step 6
    Determine how leveraged your business is. Leverage refers to how much of your business's operations are financed by debt (vs. owners equity). While leverage can allow a company to grow quickly, it is also often seen as a risk because of the chance that a company could fail to make payments. One of the best ways to judge how much a business is leveraged is the debt-to-equity ratio. This ratio is found by simply dividing total debt by total equity (money paid in by owners and retained earnings). A high ratio indicates that the company has taken on a lot of debt to finance growth.[8]
    • The key is determining whether or not a company can remain profitable while using debt financing. If the company is highly leveraged, but growing and profitable, it is still taking risks but seems to handle them well.
    • Highly leveraged companies, such as utilities companies, require a very stable amount of income and cash flow to maintain stability.
  3. Image titled Value and Assess your Business Step 7
    Assess your business's past and future growth. To get a sense of where your business might be going, look at growth in revenues and profit over the past few years. Have your revenues grown consistently? Are your profits growing with them or stagnant? If one of the two is not growing, this may be a sign that your marketing is failing or that your expenses are rising. Either of these should be reason for concern and warrant an investigation of business practices so that a change can be made.
    • You should also analyze market trends to try and figure out how the economy has and will affect your business's performance in coming years.
  4. Image titled Value and Assess your Business Step 8
    Check the financial ratios. While analyzing the balance sheet, income statement, and statement of cash flows, sales and operating ratios should be calculated in order to point out areas requiring further study. Key ratios are the current ratio, inventory turnover, the receivables turnover ratio, return on assets (ROA), return on equity (ROE), and the debt to equity ratio. Look for trends in the ratios over the past three to five years.
    • The current ratio analyzes a business's ability to pay off its debts with its assets. It can be found by dividing current assets by current liabilities. A high ratio often indicates that a business is very capable of paying off its debts and is in good financial health.[9]
    • Inventory turnover is calculated as sales divided by inventory. This represents how often during a period inventory is turned over, or sold to customers. If this ratio is high, the company is able to effectively move product and is not bogged down by excessive amounts of inventory.[10]
    • The receivables turnover ratio is calculated as net credit sales for the period divided by the average accounts receivable balance for the period. This represents a company's effectiveness in collecting on customer orders paid with credit. A high value is preferred.[11]
    • The return on assets (ROA) ratio seeks to show effectively a company uses its assess to produce profits. It is calculated as net income divided by total assets.[12]
    • Return on equity (ROE) is similar to return on assets, but shows the relationship between money invested by shareholders and profits. ROE is calculated by dividing net income by shareholder's equity.[13]
    • The debt to equity ratio shows shows how a company has been financed, comparing the contributions of debt financing and shareholder investment. It can be calculated by dividing total liabilities by shareholder's equity.[14]

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Categories: Buying & Forming a Business