Alt.tag: Calculating risks with pen, paper, and computer before selling your business.
When you are in a situation of selling your business, "What's your right asking price?" is the most common question you can ask yourself. Well, the assessment of your business' real value is a bit of a tricky thing. It can't be accomplished strictly by using just one method or approach, and you will never get the exact number. Instead, in the best case scenario, you will get the range of values you can use to determine the appropriate price. Business valuation is a series of processes used to provide you with the approximate economic value of your businesses. In other words, the present financial standing of your company, as well as the future prediction of profitability. For this reason, let's see some of the most common business valuation approaches.
Selling your business? What's your right asking price
Just to clarify one thing before describing various valuation methods: As said before, no single way of approach can assess your entire business' worth. Different values are important to different people, in this case, potential buyers. Some will appreciate the connection of your business to the community. Others see worth in a prospective future potential for further development. At the same time, there are those who will appraise your business by looking at the historic income. For this reason, there are calculations for each aspect of a business.
Common valuation methods when selling your business
Depending on your situation, you can use one, or several common business valuation methods:
- Asset-based method
- Market value method
- Return on investment (ROI) method
- Income-based method
In the center of this method is your business' total net asset value. It is calculated as deducting liabilities from the market value of your total assets. The asset-based method is often used in close relation to the equity value method and the enterprise value method. The most common use of this method is in cases where a company is experiencing some liquidation issues. For that matter, the goal is to acquire the highest possible business value. This is more likely to be better than by disposing of your assets one by one. On the other side, the negative thing is that this method disregards the company's prospective earnings. The asset-based method is a preferred method if you are just relocating. You will transport your movable assets using moving services for your commercial needs, and then just sell the buildings.
Just like in the board game Monopoly, you are dealing with your assets. Alt.tag: Monopoly game representing business selling and buying.
Market value method
The market value method is a form of relative valuation in which you are doing a comparison to other companies in the same industry that are acquired or sold lately. This method is also known as the market comparison approach and the market-based approach. The main thing here is to search for businesses that are comparable to your business. It is done by looking at matters like assets prices, and then adjust them for different quality, quantity, or size.
To do this the proper way, you need to compare these things:
- Are the companies operating in the same industry?
- Do they offer identical services or products?
- The location of the companies you are comparing
- How much profit do they make?
- Are they similar in size?
- Is any company operating in multiple industries?
Is your business the same as the other one? Alt.tag: Two man-like figures and different stairs, metaphorical representation of different businesses.
Return on investment (ROI) method
The ROI method is based on assumptions and prediction of values your business could produce in the future. It is a widely used method for predicting the gain or return from an investment. For this reason, this method usually produces the highest values. In combination with other methods, it results in the most accurate valuation. It is often presented as a percentage returns on the capital investment, relative to the investment's cost. ROI is a very popular method for its understandability and versatility. If a business' ROI calculation, which is not too complex, is net positive, then your business will probably be worthwhile for buyers and brokers.
Everything is about profit, especially if you are selling your business. Alt.tag: Coins and pens piled on paper, representing selling business calculations.
Income-based business valuation methods
The income-based business valuation methods, which ROI method is a part of, are all value-based methods for calculating income producing capacities and risks. Where business risks are in the form of capitalization and discount rates. The most commonly used income-based valuation methods in business assessments are:
- Discounted cash flow - The DCF method is basing its valuation on a projected cash flow of your business. The discontinued cash flow is best in a situation when you don't expect your business to have a stable profit. It takes the predicted future net cash flows and discounts them to the present values. Among other things, considering inflation and other negative aspects is the advantage of this method.
- Capitalization of earnings - This method calculates the profitability of your business accounting, the expected values of cash flows and the annual ROI. Since this method assumes the calculations for a single time period will continue in the future, it is the best valuation method for stable businesses.
- Multiple of discretionary earnings – This is a notable capitalization technique that calculates the top value of your business by setting a multiple to your present value. The multiple can be different depending on the industry, business type, owner preferences, and market.
Which method is the right method?
There is no single best method for calculating its value when selling your business; no one "do it all" method you can use. The best way to approach this problem is by using and combining several methods according to your needs and predictions. Income-based methods may be the most popular business valuation methods, but, for most businesses, and in most cases, a certain combination of methods is the safest way to deal with selling so you won't lose any money. It all depends on the industry, size, and many different factors that determine your business orientation. While mastering all methods will take you a lot of time, maybe the best thing would be to hire a professional business validator. Because they will have the experience and knowledge of the market trends to properly advise you how to sell your business.