How to Determine the Valuation of Your Business

How to Determine the Valuation of Your Business

Owners may contemplate selling, acquiring, or seeking funding as a business evolves. You might even be approached with an offer. And while plenty of owners decide they are happy to continue forward at full steam, there are good reasons to think through all the options.

It’s essential to assess all options and understand how to determine the value of the business. A survey conducted by U.S. Bank’s Jessie Hagen revealed that 82% of business failures are attributed to inadequate cash flow management. This high rate of failure highlights the importance of effectively controlling cash flow, which can be easily managed.

Different valuation approaches work better for different business types, and choosing the appropriate one can help maximize returns on any transaction.

Tip #1: Beware of valuation limitations

Before delving into the various approaches to determining the value of a business, it is crucial to acknowledge its limitations.

Business valuation is a blend of art and science, and the ultimate value of a business is what a buyer is willing to pay for it. External factors, such as market trends, technological advancements, or infrastructure developments, can influence the business’s value.

Moreover, projecting values into the future is complex, and certain factors like brand equity or goodwill are hard to quantify. Using multiple approaches to business valuation can help generate values from various methods, providing more confidence in the process.

Tip #2: Understand the basics

According to a study by IBISWorld, the business valuation market size in the US is expected to reach $11.7 billion by 2026, with a CAGR of 6.2%. This growth reflects the increasing importance of business valuation in decision-making processes such as mergers, acquisitions, and fundraising.

Determining the market value of your business is crucial in various scenarios, such as preparing for a merger, selling your business, or assessing your business’s position in the industry.

Other reasons include:

  • The requirement for loans or equity to expand your firm.
  • The necessity for a more extensive tax study.
  • The intention to add shareholders.

In this scenario, the value of the shares must also be established.

The valuation process informs the owner of their business’s current worth by examining all business areas, including management, capital structure, projected earnings, and the market value of its assets.

Tip #3: Take note of the top approaches

There are three basic techniques for business valuation when your firm is ready. Each has its advantages to consider, so decide which is ideal for you and your company.

Asset-based Approach

To assess the worth of a company, an asset-based approach adds up all of its investments. When you choose an asset-based strategy, your investments will be summed in one of two ways:

  • Book value approach. A going concern asset-based strategy, also known as book value, will examine your company's balance sheet, listing all of its assets and subtracting all of its liabilities.
  • Liquidation approach. When determining the liquidation value or net cash value of your business if all assets were liquidated and liabilities were paid off, a liquidation asset-based approach is utilized. This is a frequent strategy for business owners who want to sell their company or get out from beneath it.

Asset-based techniques work effectively for companies because the company holds all assets and can be sold along with the business. However, this kind of evaluation can be more difficult for sole proprietorships.

Separating the value of business assets from personal assets if any assets belong to or are in the sole proprietor’s name. For example, if a sole proprietor is ready to sell a services company, prospective buyers would have to determine which assets belong to the business and which belong to the sole owner.

Earning Value Approach

The earning value approach examines businesses based on their future ability to generate wealth. A corporation typically seeks to acquire or combine this strategy with another. There are two techniques for earning value:

  • Capitalizing on past earnings. This method reports the company's utilization of prior earnings, normalizes them, and then multiplies the predicted normalized cash flows by a capitalization factor. This is the return on investment that a reasonable buyer would expect on their business investment.
  • Discounting future earnings. This method averages the company's expected future profits trend and divides it by the same capitalization factor.

Market Value Approach

When determining their firm's market value, owners base their decision on similar businesses that have recently sold. This might result in a company being undervalued or overpriced. Suppose your company and its assets are worth $5 million but similar companies have sold for $2 million. In that case, you may lose money on the sale.

  • Earnings value approach. This is the most common business valuation method, but it doesn't imply they're the best option for you. Combining these three strategies may be the most effective way to determine a fair and accurate valuation for your company. 
  • Comparable approach. The comparables approach to equity valuation involves using the operating performance of similar companies as a basis for comparison. By analyzing the financial information of other companies within the same sector, one can determine how the company compares to its competitors and peers.

Tip #5: Utilize business valuation tools with caution

Business valuation software can be a valuable tool in determining the value of your business. Business valuation software can be helpful for several reasons:

Accuracy: Business valuation software uses complex algorithms and data analysis to provide accurate and objective valuation estimates.

Time-saving: Valuing a business can be a time-consuming process, but with the help of software, the process can be completed faster, saving business owners valuable time.

Cost-effective: Hiring a professional appraiser or valuation expert can be expensive, but business valuation software is often a more cost-effective option for small and medium-sized businesses.

Customizable: Business valuation software can be customized to suit the specific needs of a business, providing a more personalized and accurate valuation.

Accessible: Many business valuation software options are available online, making them accessible to businesses of all sizes and locations.Overall, business valuation software is a helpful tool for business owners to determine the value of their business accurately, quickly, and cost-effectively. However, it's right to choose the right software, input accurate data, choose the appropriate valuation method, analyze the results, fine-tune inputs, and seek expert advice.

Determining the valuation of your business is a critical process that requires a thorough understanding of your company’s financial and operational performance and the broader market context. By utilizing various methods, including the asset, market, and income-based approaches, and adhering to best practices, such as using multiple valuation approaches and seeking expert advice, you can arrive at a fair and accurate valuation that reflects the true worth of your business.

Remember, a comprehensive valuation can be the difference between success and failure in transactions such as attracting investors, planning mergers or acquisitions, and preparing for an exit strategy. Therefore, properly assessing your business’s value is crucial for its continued growth and success. Using a business valuation tool, like Cyndx Valer can help you come up with an accurate and unbiased valuation. With just a few inputs of your financial data, our platform compares it to industry benchmarks and market trends to generate an accurate and unbiased valuation of your company in a matter of minutes, not weeks. You can easily access valuable insights such as comparable company multiples, expected returns for private and public companies, and long-term growth projections. 

Say goodbye to tedious valuation processes and hello to a powerful tool that can help you make informed decisions for your business’s future success. Try Cyndx Valer today.