How to calculate the value of your business? As an entrepreneur, you have worked hard and vigorously to transform your dreams into a reality.
Your successful company is an outcome of the passion, effort, and time you have put into creating your mark in the corporate world.
All this work has helped you build a company that is worth much more than just a dream, but how much is it really worth?
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Here is the content that we will cover in this post. Let’s get started.
- 1. The Need to Calculate the Value of Your Business Entity
- 2. Business Owners and Entrepreneurs Must Know How to Value a Company
- 3. What is Business Valuation?
- 4. Key Definitions and Accounts to Understand Before Calculating The Value of Business
- 5. Earnings Before Interest, Tax, Depreciation, and Amortization (EBITDA)
- 6. Seller’s Discretionary Earnings or SDEs
- 7. Calculation of SDE
- 8. Get Your Financial Data and Information In Order
- 9. Stock of Assets
- 10. Calculating the Assets
- 11. Tangible Assets
- 12. Intangible Assets
- 13. Assess Your Liabilities
- 14. Calculating the Value of Your Company
- 15. The Income-Based Approach
- 16. Discounted Cash Flow Method
- 17. Earning Capitalization Method
- 18. The Asset-Driven Approach
- 19. The Market Based Approach
- 20. Support Your Valuation Claim with Business Plan and Model
- 21. Final Thoughts
The Need to Calculate the Value of Your Business Entity
Calculating the value of a business entity is essential for all entrepreneurs.
No matter which stage of the business lifecycle your company is in, valuation can help you gauge the worth and price of your corporate asset.
It enables you to measure the level of success you have been able to achieve and compare your performance against benchmarks. And assess the accomplishment of your goals and objectives.
Business valuation is also very important for various financing events for your company.
Whether you are raising a new round of funding from investors, aspiring to take a loan from a bank, or opting to expand your existing operations.
Or want to sell or transfer the ownership of your company, you need to evaluate its worth.
By using some way of estimating the company’s value at a point in time, you can use this estimated price for making critical business decisions.
These may include mergers, acquisitions, IPOs, exit strategy, and other tax-related issues.
See How I Can Help You With Your Fundraising Efforts
See How I Can Help You With Your Fundraising Efforts
Business Owners and Entrepreneurs Must Know How to Value a Company
Ideally, you should refer to a third-party expert for this financial valuation.
However, as an entrepreneur and business owner, you should also be able to confidently come up with an appraisal for your company.
With expertise in this financial field, you can reap many benefits.
As a business owner, you will be able to pitch your proposal effectively to a potential investor and raise funds for your company efficiently. As well as the price of your business accurately to find a suitable buyer.
Additionally, if you as an entrepreneur want to buy an existing business or are looking for opportunities to invest, you should be able to conduct valuations.
This factor is essential to assess the financial health and profitability potential of a particular company.
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What is Business Valuation?
Valuation is a financial representation of a company’s total worth.
Using various formulas, the worthy value of a company can be calculated by incorporating different accounts. These may include earnings, assets, liabilities, losses, and industrial standing.
Along with these key financial numbers and calculations, business valuation also involves exercising control over your emotions and sentiments.
This is especially true if this is your first company or a family-owned business that you have put your heart and soul into.
As a professional entrepreneur, the aim is to maintain as much objectivity as possible in order to ensure an accurate company valuation.
Key Definitions and Accounts to Understand Before Calculating The Value of Business
If you are not a finance expert or a professional business evaluator, you need to understand some basic conceptions of valuation.
This will be like prep work for your actual valuation calculation and make things easier for you.
Earnings Before Interest, Tax, Depreciation, and Amortization (EBITDA)
It may sound a little complicated, but in plain business terms, it is the net profit of your business.
Large-sized companies generally opt for using EBITDA for calculating their value.
Seller’s Discretionary Earnings or SDEs
This is a number mostly applicable for smaller businesses and is similar to EBITDA.
It helps the new owner calculate the value of your business.
Unlike EBITDA it includes the owner’s income reported to the tax authorities and the non-cash expenses.
This means that it represents the actual revenue generated by the business including the salary of the owner and any benefits provided to them.
The reason for this difference is that small business owners or entrepreneurs often consider their personal expenses as company expenses.
Calculation of SDE
The before tax and before interest income is the starting point. Add any non-essential purchases including vehicles, travel expenses, and the owner’s accommodation rent.
All types of discretionary expenses like employee recreation, charitable donations, purchases of assets, and even the salary of the owner should be added in the calculations of the SDE.
You can now deduct the debts and liabilities of the company from this net income to come up with the SDE value.
Get Your Financial Data and Information In Order
The best way to organize your company’s financials (if already not in place), is to consult your accountant or finance department.
If you are small business chances are you are doing it on your own.
In that case, take time out to get your finance and account information and data in order.
Run through your records, invoices, and statements to extract valuable numbers required for valuing your business.
The accuracy and precision of these calculations will lead to accurate valuations as well.
Things that you need to ensure the truthful valuation of your business include:
- Profit and Loss Statements for the last three or more years
- Proprietary documents like leases, ownership deeds, and licenses.
- Tax returns and filing documents
- Company and owners bank statements or an overview of personal finances
With a sound financial system backing your calculations, you will be able to generate realistic expectations. And also come up with a reasonably accurate value of your company.
The better you organize your financial data and figures the stronger ability you have to validate your valuation claim.
Stock of Assets
Assets are a key element in evaluating your company’s worth. They are the actual property or resources of value that you and your company own.
But there are different types of assets that you need to consider to calculate the value of your business.
These include a list of the production objects, any property, and other valuable resources. The aim is to remain as objective as you can.
Taking the latest inventory of your assets is an essential prerequisite of your valuation process.
Calculating the Assets
Make a list of company assets. This should comprise any objects that add value to your company’s operations.
Types of assets:
These are the material holdings and resources of a company. Tangible assets may include
- Real Estate and Property
- Inventory of Products or Stock in Hand
- Cash In Hand or in Bank.
This list should include non-material elements like
- Patents and Trademarks
- Copyrights and Intellectual Property
- Brand Value
- Customer Base
- Customer Loyalty Level.
Assess Your Liabilities
Any type of debt or credit that is outstanding in your company’s accounts to be paid are called liabilities.
This is a key element in valuing your business’s worth and should be deducted from the SDE to come up with a genuine value.
In many cases, business owners opt to keep the liabilities and pay them off after selling the business.
List of liabilities may include things like
- Accounts payable
- Interest payments
- Note payable
- Business debt
- Accrued expenses.
Are you ready for more in-depth information on how to value your company? Check out this video I have created with tips I have gathered from my years of experience in the industry. You’re sure to find it helpful.
Calculating the Value of Your Company
There are three main approaches to evaluate your company’s monetary worth.
Each type utilizes different variables and distinct aspects of the business for the calculation process.
The final numerical value of your company should be the outcome of some dependable calculations.
You should follow one approach correctly rather than estimating a value by a mix and match method.
The key to an accurate estimation is to plug in the right specific financial inputs into the designated formulas and find out the results.
If you are skeptical or suspicious about any figures, it is always advisable to seek professional help from an accountant or finance manager.
1. The Income-Based Approach
This method values a company based on the expected amount of income it can generate in a given future time.
The same approach can be employed in two different valuation methods. Each is briefly described below.
Discounted Cash Flow Method
This method calculates the existing value of a company using future cash flow projections.
With a carefully estimated risk factor for each business and industry, you can discount future forecasted earning’s figures and get a present value.
The discounted cash flow method is suitable for valuing new companies that have great prospects of growth.
They may not be very profitable at present, but the expected returns are much higher in the future.
Earning Capitalization Method
This method also uses future profit forecasts to calculate the value of your business.
It takes into account key financial aspects like return on investments, the annual rate of return, overall cash flow projections, and the expected market value of the company.
Unlike the discounted cash flow method this way of estimating a company’s value relies on a single period calculation and extends it for a future period.
It does not account for uncertainty or fluctuations in the company’s operations and market.
This method is, therefore, more suitable for well-established and already profitable companies.
2. The Asset-Driven Approach
The second method for calculating a company’s numerical worth is based on the monetary value of its assets and not earnings.
It involves calculating the net asset value which is the difference between the company’s assets and its liabilities.
This type of company valuation process is helpful for the company’s internal usage as well.
It allows tracking of the company’s resource spending and asset management.
To carry out an asset-driven valuation, you should first make a list of all the tangible and intangible assets and then assign a numerical value to them.
Be sure to incorporate aspects of depreciation and amortization.
The best way is to find out the existing market values of your list of assets.
This method allows owners and buyers to assess the overall material value of a company.
It is best suited for businesses that have large investments and ownership of property and real estate.
They may not be profitable but offer a lucrative opportunity through the option of liquidation.
3. The Market Based Approach
As clearly evident from the name, the market-based approach values your company based on the existing market value of similar companies in the industry.
Using past and present data of organizational sales and purchases in the industry, you come up with an estimated value for your own company.
This method of company valuation is best for small companies operating in local markets.
The underlying requirement for making this claim a valid one is to ensure the collection of sufficient relevant data and information.
The accuracy and precision of the valuation number will also be dependent on your ability to compare it with other companies like it.
Support Your Valuation Claim with Business Plan and Model
As a confident valuator of your company, you need to annex your business plan and business model with your valuation.
This will ensure that the recipient understands how you made the future projections of profits and growth.
It allows potential investors or buyers to recognize your company’s ability to grow and offer profitability in the times to come.
The business plan also holds valuable information like location, mission, and operational technicalities.
It also includes details on the products and services your company offers in the market.
Enlightening your audience with the business model helps them to understand how your company makes money.
It explains the type of business it is pursuing like eCommerce, drop shipping, business to business, consultation, retail, distributions, or anything else.
The valuation will give the worth of your company in monetary terms.
However, the business model will showcase its ability to generate good revenue and future value for the buyer.
All types of company valuation methods have their own pros and cons.
However, they are still the most acceptable ways to calculate the value of your business.
For the highest accuracy and most truthful depiction of your company’s worth, it is best to utilize more than one method of valuation.
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