How to Value a Business: A Complete Guide

After years of hard work, struggles, tears and joys, you have reached that point. You knew this day would come. All those years of thinking that someday you would exit, someday you would retire or move on.

You are ready to sell your business.

Or, perhaps, maybe you are not quite there yet, but thinking about the end game. Thinking into a not-so-distant future.

Whether you are about to sell, or just planning ahead, now comes a whole new set of things to consider.

You need a price tag, right? Okay, what is this business worth? What is the company valuation?

When you decide to sell, it is not necessarily a sigh of relief, but rather more additional stress. Operating the company was one thing, now you want to know how to value a business.

The business valuation begs the question, has my golden egg really hatched?

And if it hasn’t hatched, if it needs some more time, you will want an idea of what to do or what to focus on to get your business where you want it to be.

Smart planning is planning ahead, so let’s go ahead and dive into the details.

The Importance of a Business Valuation

Commonly, a business valuation can be thought of, really, as an appraisal of a business. Similar to selling a home, car, or antique, it estimates the worth of the business.

Even if you are not looking to sell in the immediate future, it is good to have an idea of how much your business is worth. Knowing the business valuation can help with possible disputes, whether from the IRS, a legal issue, or something inside the company.

While a company valuation is good for selling, it is also good for introducing partnerships, changing owners, or accessing a loan.

More Reasons to Know Your Company Valuation

First and foremost, knowing your business valuation sets a baseline on how far you’ve come since you opened up your business and how your company measures up to its competitors. In turn, it can be key in understanding how you can grow your business.

A company valuation is a way to make better decisions when it comes to business strategies, marketing plans, and sound financial goals.

If you are near retirement, you are likely thinking of an exit strategy. Don’t rush selling your business, because you want what is fair and what is best for your employees.

With a proper business valuation, you are in a better position to protect your most prized and special asset. There are many reasons for such an added layer of protection because life happens. Things like taxes, legal dilemmas, divorce, and death can happen without warning.

A Business Valuation Helps With Succession and Sale Planning

Think of it as planning for success. It is a good practice for company owners to plan their succession. This can cover from five years to ten years from now.

Annual business valuations help with staying on track for your succession planning. It can also help with weighing options, such as the pros and cons of selling the business.

Succession planning helps to make informed decisions about what to improve or realize in a business. It helps reach a company’s mission before passing the helm to the next captain.

Business Valuations Can Help When You Hit a Snag

You may come across a few challenges while running the business and you may need some more cash to get through and grow your business. Or, perhaps you need extra finances to acquire a new business.

This is when a business valuation comes into play. Lenders will want to know your company valuation before approving a loan.

How Do You Value a Business

A business valuation is not for ego or vanity. It is an essential part of business and a good indicator of your business’s health.

It represents your company’s total worth for a variety of reasons. When beginning down the path of how to value a company, you will find a plethora of methods. Here are a few things you want to know.

Business Valuation With an Asset-Based Approach

This can also be called a book value. An asset-based approach will use the business’s balance sheet and total assets, minus total liabilities.

Or, there is a liquidation asset-based approach. This finds the liquidation value. Or, it finds the net cash as a result of a company being sold, and its liabilities are paid and squared away.

How to Find the Value of Company Assets

Gather information on all the equipment and inventory, anything and everything that the company owns. You must determine the value of these items.

Business assets are items that are owned by the company and have value. This can span a multitude of categories, such as both physical and tangible goods. This can be real estate, vehicles, computers, furniture, machines, etc.

Or, there can be intangible assets like intellectual property that have value.

Next, take a look at liabilities and debts. Subtract this from what your business owns.

While the business valuation is dependent upon its balance sheet, how to value a company is more than just its net assets. Additionally, look to the future. What do you expect from earnings and revenue down the line?

Maintaining an awareness of the value of a company’s assets is an important duty for the financial executives in your company.

Company Valuation Based on Revenue

How to determine the value of a business is also dependent upon the annual sales it generates. A stockbroker or business broker can help you with this.

The industry your business is in likely has standards or a typical amount of annual sales. The average amount could be double what you have, so definitely seek a professional to help you with business valuation services.

Business Valuation Revenue Multiple

When you are determining the business valuation in the early stages of opening a new business, a revenue multiple may be most suitable. Often at early stages, businesses are reinvesting their revenue, so cash is flowing back through the business. This is a method to attempt massive revenue growth.

Essentially, a revenue multiple is a good method early on to determine business valuation when the focus of the business is generating more annual recurring revenue.

Of course, when using a revenue multiple, it should be true and must be accurate. It should also be comparable. Then, a reasonable company valuation is attained.

EBITDA or Earnings Before Interest, Taxes, Depreciation, and Amortization

EBITDA is important to the business valuation because it can measure the overall financial performance of a company. In some circumstances, it can be used as an alternative to net income.

Keep in mind that EBITDA can be deceitful as it removes the cost of capital investments such as plant, equipment, and property.

EBITDA also excludes expenses related to debt. It adds back interest expenses as well as taxes to earnings.

Regardless, EBITDA is a more accurate measure of corporate performance. It presents earnings before alterations are made by financial deductions and accounting.

In simple layman terms, EBITDA measures profitability which is why it is so important in how to value a company.

Tax, interest figures, and earnings are located on the income statement. Typically depreciation and amortization numbers are placed in the cash flow statement or in the notes section of the operating profit.

A common shortcut to find the EBITDA is to begin with operating profit. This is also known as EBIT or earnings before interest and tax. Then, tally back depreciation and amortization.

While an EBITDA is good for the business valuation of a large business, likewise an SDE may be better for a small business valuation.

SDE or Seller’s Discretionary Earnings for Business Valuation

Similar to EBITDA, which we just discussed, calculating your SDE or Seller’s Discretionary Earnings is an important piece of business valuation to help determine the true value.

SDE includes expenses such as non-cash expenses and the income reported to the IRS. This helps a buyer, particularly, in determining how to value a small business. It tells the story of what revenue your company is generating in reality.

Different from the EBITDA, the SDE calculation adds back the owner’s benefits and salary. It is critical for potential buyers of your business to know your SDE.

How to Calculate SDE

If you are ready to find the SDE for your company valuation, begin with your pre-tax, pre-interest earnings. Next, add purchases that are not necessary for operations. This can be travel or vehicles, things that you would consider a business expense.

What else can you include in your SDE? SDE can include your own salary, charitable donations, employee outings, and one-time purchases.

When giving your business valuation to a potential buyer, the buyer may ask for your discretionary cash flow. It is important that you prepare ahead of time for this, including the value of each major purchase or expense.

Lastly, SDE must include current debts or future payments. These are called liabilities and must be subtracted from your net income as a part of this calculation.

Business Valuation Based on Multiple Earnings

How to value a business for sale can be measured by a multiple of the earnings from the company. Or, referred to as P/E, price-to-earnings ratio.

Business valuation can be reached by estimating the next couple of years. Projected earnings can determine the value of a business.

Cash Flow Analysis at a Discount

How to value a company can be reached with a discounted cash flow analysis. This is a complex formula. It dives into your company’s annual cash flow and projects what it will be in the future. Then, it discounts the value of the cash flow in the future back to today.

This type of analysis or calculation is called “net present value.” A quick search online for an NPV calculator can help you with this.

You want the DCF (discounted cash flow) to be over the present cost of investment. If this is the case, then you are looking at a positive return as a result.

Oftentimes, businesses will use the weighted average when it comes to the discounted rate for the cost of capital. This takes into examination the rate of return that a shareholder can expect.

Keep in mind that DCF or discounted cash flow may prove to be inaccurate as it has its limitations.

A Company Valuation With a Market Value Approach

There are a few ways to determine your business valuation. Another method you can use to find your business valuation is with a market value approach.

This approach will find the value of your business by correlating it with similar companies that have sold lately. Just like selling a home or a car, this method of business valuation can work if there are enough businesses to compare to in the marketplace.

If there are not many, or really any, comparable companies, you’ll want to try the aforementioned methods and analysis for finding your business worth.

A company valuation of a sole proprietorship is particularly challenging for a market value approach. Sole proprietorships are owned by individuals by definition. Looking for public information on previous sales for a comparable company can be quite rough.

How to Value a Business is More Than Financial Formulas

Remember that your business valuation is not based on a few calculations and crunching of numbers alone. The geographical location of the business helps determine the value, especially when it comes to how to value a small business.

Furthermore, what is the potential strategic value in the marketplace? A potential buyer will want to look at synergies and how it could upsell or add clientele to its current business.

How to Value a Business the Right Way With the Experts

With 45-years of experience in selling businesses, it makes sense to sell your business, your precious work, your golden egg, with someone who knows what they are doing and with someone you know who cares.

That’s why you want to reach out to Dolan Sales and talk with Bob and Alana Dolan. We can streamline your selling process and we will maximize your return.

We know you earned it. Contact us today.