How to Value a Business
The true value of a business is what someone is willing to pay for it. That said, if you are buying or selling your business, there are different ways to value a business.
There are two key factors to keep in mind;
- How much profit will it make?
- How much risk is involved in making that profit?
To start with do you know: the past cash flow, previous trading profitability and the value of the assets?
All business valuations are a balance of a range of influencing factors. These are a combination of strict business numbers and emotional issues that drive the decision. Each buyer and seller will use a combination of factors to set their price. Some may seem irrational to you. This is when comprise begins and the bargaining process takes over.
Key Factors:
- Why is the seller selling now? Do they want to retire? Have they got three years of excellent numbers in the business with clear growth ahead? Has the sale been forced? Have they run out of cash, become ill, had a fight with a business partner? Knowing the reason is a vital negotiating tool.
- Are you buying tangible assets you can quantifiably value? Is the stocktake of $125,000 really worth that in the market today? Or is it last year’s stock that you are now expected to buy at an inflated price?
- Has the owner placed value on a range of intangible assets? You may be asked to pay a price for their brand, customer goodwill or intellectual property. These assets may truly be worth something, but is it what the owner wants. It’s important you do your due diligence to decide.
What valuation technique will you use to determine what to charge or pay?
1. Industry Norms
Many industries use commonly accepted historical calculations. These may be based on turnover, number of clients or profit. It’s important you do research before starting the conversation.
2. Set up Cost
What would it cost you to get to the same level of business? The buyer may be willing to pay you for your time and effort to this point.
3. Asset valuation
Assets less liabilities become the net asset valuation. The buyer may only be interested in the assets and not the actual business. It’s important you agree on the stated value of the assets at the time.
Sometimes a combination of these methods is used to value a business.
Always have a professional accountant review your business numbers.
Our very own Springwood Accountant Nathan, has extensive experience in reviewing businesses. Give him a call and make sure you receive or pay what the business is worth.