Last Updated on
Getting ready to sell your business? Tapping into equity to grow? Maybe you’re looking for investors to finance future operations?
Then you need to determine the value of your small business.
We’ll walk you through the process, providing you with the practical tips and resources you need to find the best approach for your situation.
- Are you only after valuation methods? Jump to our section discussing the three most popular business valuation approaches.
- Want to do a quick DIY business valuation? Jump to our simple valuation calculator.
What is a Business Valuation?
How much is your small business worth?
If you’re not sure, you’re not alone.
Determining the value of a small business can be a complicated affair. There are so many variables involved in the calculations. But coming up with a business valuation doesn’t need to be hard, especially once you understand the basics.
Business valuations can be a DIY project (try our simple calculator now), but you can also have one performed by a qualified professional. In the U.S, Accredited in Business Valuation is an official designation awarded to Certified Public Accountants.
And, depending on who you ask, a professional appraiser is the better option. You’ve built your business from the ground up. Perhaps that passion might make it tough to turn in an accurate business valuation.
No matter which route you choose, it helps to understand the process.
Your business valuation includes all of your assets, such as:
- Your business equipment
- Your inventory on hand
- The property you own
- Any liquid assets such as cash or funds in a checking account
In some cases, your assets may even include things like project earnings and future revenue.
Factors Impacting Your Business’ Valuation
Once you’ve taken stock of your assets, keep in mind that many elements will influence their worth.
For example, if similar businesses have sold recently, the appraiser will factor their sales prices into their calculations.
Your appraiser may also look at things like:
- The concentration of customers living within a specific distance from your business
- How well your business compares with others in your industry
- Governmental regulations, either current or pending
- Reliance on suppliers and whether there may be a supply chain disruption in the future (e.g., trade wars disrupting the import of a specific commodity)
- Current economic conditions (one great source is the Federal Reserve’s Beige Book)
Finally, appraisers can only consider information that is verifiable. If your financial statements and other supporting documentation aren’t well-organized (or even missing), this may hurt your valuation.
Determining the Value of Your Small Business with Our Calculator
Quickly determine the value of your small business with our valuation calculator. We’ve used the multiples of earnings method, which is based on your specific industry.
You can find more detail about your industry multiple here. Although this might give you a better idea, this is a simple valuation and only intended to be an estimate.
Business Valuation Methods
There are a few business valuation methods. Here’s an overview of the most common approaches.
|Income-based||Focuses on the income the business will generate in the future, example methods are Discounted Cash Flow and Capitalization of Earnings||Discounted cash flow is ideal for brand new businesses with lots of potential
Capitalization is best for stable, established businesses
|Asset-based||Calculates all business assets minus liabilities||Businesses with assets, like real estate, that are shutting down|
|Market-based||Based on the sales of similar companies||Most businesses but only effective if enough purchasing data is available|
How to Determine the Value of Your Small Business
One easy way to get an idea of how much your small business is worth is to look at your balance sheet.
This method, which gets you your business’ book value, is determined by subtracting your liabilities from your assets.
Unfortunately, this is a very simplistic view of your business. Still, your book value will give you a good idea of how things are faring. Think of it as a snapshot of your business’s financial performance.
When it comes to more complex calculations, there are three broad classifications of business valuation methods:
- Income-based approaches
- Asset-based approaches
- Market value-based approaches
We’ll dig into each one below.
Income-based valuations value your company based on the amount it is expected to generate.
There are two frequently used income-based approaches: Capitalization of Earnings and Discounted Cash Flow.
Capitalization of Earnings
When you use this method, you are calculating your business’ future profitability.
There are multiple ways of doing this calculation, consider:
- Your cash flow
- The annual return on investment
- Your business’s future value
Capitalization of Earnings is best for established, stable businesses that see themselves continuing on in the future.
Discounted Cash Flow (DCF)
Discounted cash flow (DCF) looks at your expected cash flow–the total amount of money going in and out of your business. You adjust (or discount) the cash flow based on the present value of money.
The concept is based on the time value of money; the idea that the same amount of money is worth more if we can access it right away, instead of in the future. Consider the saying this popular saying: “A dollar today is worth more than a dollar tomorrow.” It’s one of the most common business valuations approaches.
Asset-based valuations focus on the worth of all business assets.
There are two ways to do so:
- With the going concern asset-based approach, you tally up all of your assets and your liabilities. You subtract the liabilities from your assets, and the number that results is the valuation for your small business.
- With a liquidation asset-based approach, you determine how much cash you would have if you paid off all of your liabilities and sold off all of your assets.
If you are shutting down your business, the liquidation approach is your best bet. Otherwise, opt for the going concern approach. Though, this calculation will be difficult for sole proprietorships. For example, how do you separate personal assets from business ones?
Market Value-Based Valuations
Market value-based calculations rely on comparisons. So, the appraiser looks at similar businesses that have sold recently. Then, based on factors like how your business is similar (or different), the appraiser comes up with an appropriate valuation.
Calculating a market value-based valuation is only effective when you have a large number of comparable businesses that have been sold recently. Typically, it’s tough to find this kind of public data; sale details are not always published.
That’s why these are best for preliminary calculations.
Other Business Valuation Methods
In addition to the primary methods of business valuation we mentioned above, there are other additional–less commonly used–methods:
Times Revenue Method
The times revenue method (also known as multiples of earnings) works by multiplying your business profit. What this means is the appraiser takes your current level of revenue and multiplies it by a specific multiplier. That multiplier depends on factors like your industry and the current economic climate.
Return-on-Investment (ROI)-Based Valuations
When you evaluate a business based on its earnings, you are looking at the potential for the business to generate a return on your investment in the future. There are many factors that go into an ROI-based valuation, including:
- How long it will take the investor to recoup their investment
- What is the likelihood that the investor will recoup their investment (the more risk the investor undertakes, the bigger their expected return will be)
Improving Your Small Business Valuation
Now that you have an idea of what methods are used to evaluate your small business, here are some things you can do to improve your small business’ valuation.
Get Your Documentation in Order
While most business valuation methods rely on guesses and estimates to some degree, you’ll need some kind of evidence to back up your facts.
So, one of the best things you can do is to organize your documentation.
For instance, you’ll want to prove:
- You own your assets
- Your liabilities are represented fairly
- You own the business and your property/equipment
Tax returns and other official documentation are key for providing a solid understanding of what your company looks like financially.
Beyond all of this, most investors would be wary of a business that didn’t have its book in order.
Know Your Assets and Liabilities
Think of assets as anything you own that has positive economic worth. Liabilities are debts and other obligations–any amounts owed by your business.
There’s a caveat, though: these definitions are not all-encompassing. So, when you are tallying up your assets and liabilities, you will want to be thorough. In addition to physical assets and the obvious liabilities (e.g., loans), consider what else you have that cannot easily be classified.
Unfortunately, whether something is considered as an asset or a liability is highly-variable. In some cases, an asset in one industry can be a liability in another!
Make Structural Changes to Your Business
If you are not in the process of performing a business valuation (or will not be doing so for some time), consider making structural changes to your business to maximize the amount of your value computation.
Some of the goals you can aim for include:
- Increasing your overall revenue
- Lowering expenses (or keeping your expenses the same while increasing your revenue)
With sufficient time, you may be able to improve your business’ financial numbers to boost your business valuation.
Brief Aside: Communicating with Your Staff
If you are performing a business valuation for the purposes of selling off your business, consider keeping your employees in the loop. There will certainly be times when information needs to stay confined to a select group. However, keeping your staff informed likely will make the process, from beginning to end, easier for everyone.
Knowing how much your business is worth is important if you’re looking to gain investors or trying to sell your business. But there are many different ways to arrive at your small business valuation.
If, however, you are not comfortable performing a business valuation by yourself, enlist the services of an appraiser. Qualified professionals will likely hold the Accredited in Business Valuation designation or be listed with the American Society of Appraisers (ASA).