Hi, Can you explain me how do I value a business?
This valuation method often renders the lowest value for your company because it assumes your company does not have any "Good Will." In accountant speak, "Good Will" has nothing to do with how much people like your company; Good Will is defined as the difference between your company's market value (what someone is willing to pay for it) and the value of your net assets (assets minus liabilities).
This valuation method often renders the lowest value for your company because it assumes your company does not have any "Good Will." In accountant speak, "Good Will" has nothing to do with how much people like your company; Good Will is defined as the difference between your company's market value (what someone is willing to pay for it) and the value of your net assets (assets minus liabilities). Typically, companies have at least some Good Will, so in most cases you get a higher valuation by using one of the other two methods as described below.
When retained to value a business we use one or more of the three internationally accepted business valuation approaches: the asset approach, the income approach and the market approach. The Asset Approach: The asset approach determines the value of a business based on the replacement or realisable value of all assets less all liabilities. This approach takes the balance sheet value of the business and makes adjustments to the value of assets to reflect their replacement or realisable value depending on whether the business is being valued on a going concern or liquidation basis. The book value of some assets such premises or equipment in a going concern business can often be less (or in some cases more) than their replacement value whereas the stated book value of stock and accounts receivable can frequently be more than what would be realised if the stock was disposed of and debtors were collected if the subject business is being valued on a liquidation basis. The asset approach does not take into account the value of goodwill or the earnings potential of the business and as such is most frequently used to value loss making, capital intensive or non operating businesses where the value of net assets exceeds the present value of anticipated future earnings from those assets. The Income Approach: The income approach calculates a value based on the assumption that the value of a business is equal to the risk adjusted present value of all future cash flow. In other words, the business value is based on the company’s ability to generate future income. The two most common methods within this approach are the Capitalisation of Earnings method and the Discounted Cash Flow method. Where the current level of earnings are expected to continue into the future the Capitalisation of Earnings method is typically used but where current earnings are not a reflection of expected future earnings the Discounted Cash Flow is the most appropriate method to use The income approach is frequently used to value going concern businesses whose future earnings can be forecast with a reasonable degree of confidence. The Market Approach: The market approach calculates the value of a business based on comparisons to similar companies for which values are known. These comparable companies may have their shares publicly traded on the Dublin, London, New York or other stock exchanges (Guideline Public Company method) or they may be private companies which were sold with the terms of the transaction disclosed (Comparable Transaction method). The subject company is valued by reference to what similar companies or interests in companies have previously sold for and expressing that comparison relative to some fundamental variable in the subject company, such as sales, profit after tax, EBITDA (earnings before interest, taxes, depreciation and amortization), EBIT (earnings before interest and taxes), etc. Every business we value is unique. The facts and circumstances of each valuation determine the best approach and method to use. Thanks
**The three methods below to triangulate around a realistic value for your company:** Assets-based ------------ The most basic way to value a business is to consider the value of its hard assets minus its debts. Imagine a landscaping company with trucks and gardening equipment. These hard assets have value, which can be calculated by estimating the resale value of your equipment. This valuation method often renders the lowest value for your company because it assumes your company does not have any "Good Will." In accountant speak, "Good Will" has nothing to do with how much people like your company; Good Will is defined as the difference between your company's market value (what someone is willing to pay for it) and the value of your net assets (assets minus liabilities). Typically, companies have at least some Good Will, so in most cases you get a higher valuation by using one of the other two methods as described below. Discounted Cash Flow -------------------- In this method, the acquirer is estimating what your future stream of cash flow is worth to them today. They start by trying to figure out how much profit you expect to make in the next few years. The more stable and predictable your cash flows, the more years of future cash they will consider. Once the buyer has an estimate of how much profit you're likely to make in the foreseeable future, and what your business will be worth when they want to sell it in the future, the buyer will apply a "discount rate" that takes into consideration the time value of money. The discount rate is determined by the acquirer's cost of capital and how risky they perceive your business to be. **Rather than getting hung up on the math behind the discounted cash flow valuation technique, it's better to understand the drivers of your value when using this method, which are:** 1) how much profit your business is expected to make in the future and 2) how reliable those estimates are. Note that business valuation techniques are either/or and not a combination. For example, if you are using Discounted Cash Flow, the hard assets of the company are assumed to be integral to the generation of the profit the acquirer is buying and therefore not included in the calculation of your company's value. A money-losing bed and breakfast sitting on a $2 million piece of land is going to be better off using the Asset-based valuation method, whereas a professional services firm that expects to earn $500,000 in profit next year, but has little in the way of hard assets, will garner a higher valuation using the Discounted Cash Flow method or the Comparables technique described below. Comparables ----------- Another common valuation technique is to look at the value of comparable companies that have sold recently or for whom their value is public. For example, accounting firms typically trade at one times gross recurring fees. Home and office security companies trade at about two times monitoring revenue, and most security company owners know the Comparables technique because they are often getting approached to sell by private equity firms rolling up small security firms. You can typically find out what companies in your industry are selling for by asking around at your annual industry conference. The problem with using the Comparables methodology is that it often leads owners to make an apples-to-bananas comparison. For example, a small medical device manufacturer might think that, because GE is trading for 20 times last year's earnings on the New York Stock Exchange, they too are worth 20 times last year's profit. However, I can tell you, after analyzing more than 13,000 businesses that use The Value Builder System that a small medical device manufacturer is likely to trade closer to five times pre-tax profit. Small companies are deeply discounted when compared to their Fortune 500 counterparts, so comparing your company with a Fortune 500 giant will typically lead to disappointment. Finally, the worst part about selling your business is that you don't get to decide which methodology the acquirer chooses. An acquirer will do the math on what your business is worth to them behind closed doors. They may decide your business is strategic, in which case back up the Brinks truck because you're about to get handsomely rewarded for your company. But in most cases, an acquirer will use one of the three techniques described here to come up with an offer to buy your business.