As a fledgling business, the last thing on your mind may be valuing your business to see how much it is worth.
But it is not an exercise that only needs to be carried out if you decide to sell your business. Valuing your business is needed for investment purposes too – you may consider taking on a partner or as part of your financial forecast, you may be looking to acquire significant financial investment.
How to value your business?
There are three main approaches to putting a financial value on your business:
- Asset based
- Cash flow based
- And comparing your business to another comparable company
With the asset-based approach, you value everything that belongs to your business (property, equipment etc.) and add it all together.
For a small business, the asset-based approach is not usually the best way of valuing it.
A cash flow analysis forecasts the future expected revenue and costs arriving at an expected net profit. You run the same forecast for a period of time, usually five years and then calculate what is known as the terminal value. A discount rate is applied as this reflect the time value of money and the risk in the business.
Theoretically, it is the best way of valuing your small business but it needs to be used with caution. It is a complicated equation and prone to mistake.
The ‘Rule of Thumb’ Model
For a small business, the ‘rule of thumb’ may be a good model to use.
To do this you reassess last year’s accounts to calculate the actual net profit for the business’s owner. When you have this figure, you multiply it by a related multiple – this multiple depends on whether you occupy the service industry, for example, or retail, manufacturing etc.
For example, small service related businesses are valued at somewhere between 2 and 2.5 times the annual adjusted net cash flow.
For small businesses occupying other sectors, such as manufacturing, the multiple is higher, usually around 3 to 3.5 times.
What this means is, is that as a ‘rule of thumb’ your manufacturing based business could be worth 3 to 3.5 times more in a year’s time than it is today. This, of course, depends on the economy being good, the right risks being taken and so on.
The third method mentioned above is a comparative value. This is possibly the simplest but also one that may leave you short changed or asking too much for the sale of your business.
Find a similar business to yours that has recently sold and use this sale price as a guide.
Business Valuation – Science, Art or Alchemy?
Valuing any business, big or small, is a careful balance between art and science. But a lot depends on perception – if you are asking a high price for your business, does it meet the elevated expectations of potential buyers? What does too low a valuation mean to punters too?
Founder/ Head of Investment Advisory