How do I value my business?
How to calculate the value of my business? A topic I cover regularly, In fact, I was talking to a business owner recently about the value of his business, now and in the future.
There are various ways to value a business, but all are irrelevant if someone is not prepared to pay that amount. So, what is the rule of thumb for valuing your business?
When looking at the value of a business, we look at the intrinsic value, whether people would be prepared to buy and what they would be prepared to spend.
Of course, there is no accounting for folk and people often surprise me with the decisions they make so all is theory until you have the money in the bank.
Businesses are usually bought for future cash flow and profit potential. The buyer will have seen a way of making more money from running that business themselves or disposing of the assets themselves to gain more than they had to pay out.
How to calculate the value of your business
Asset Stripping; What assets do you have in the business and what are they worth?
Fundamentally, if you closed up shop today what could you convert into cash? This is often called a ‘fire sale.’
Most of these assets will be shown on the balance sheet, but probably not at the cash value.
Fixed assets may have been purchased many years ago and depreciated through the years. There might still be value in them, and a good depreciation policy should have ensured that that was reflected in the carrying value, but in our experience, this is unusual.
Intangible fixed assets around goodwill, brand recognition, and intellectual property, such as patents, trademarks, and copyrights, may all have a value that is hard to quantify until someone tries to buy.
Current assets such as stock and debtors will need to be revalued if the business in question is not being continued.
Will you need to reduce the stock value to sell?
Multiple of turnover
An example of this is Accountancy practices. They are generally valued as a multiple of turnover and depending on market conditions can be anywhere from 0.8 – 1.4 times turnover.
Fee income for accountants is relatively stable with full of repeat business, if the new owner buys the fee bank, does a reasonable job, and gets paid, they are likely to retain that client for a couple of years at least.
This model works as most accountants would understand the business model and would be prepared to subsume the work into their existing team structure.
It does not work with most industries where turnover is more subjective and profit percentages variable and dependent on many factors.
Multiple of profit
If we look instead at multiples of profit, an outside entity may have difficulty determining the true profit from the accounts.
Financial accounts are not prepared in such a way that the true profit can be instantly ascertained.
To get a true valuation of a business, we also need to find the adjusted net profit which accounts for extraordinary or special items.
For example, where businesses have been owner-managed the owners’ wages need to be adjusted for market rates, whether that is to be increased as the owner has been underpaying themselves, or deleted as their work can be taken over by the buyer’s team.
There are a number of items that will affect the multiples and the following will need to be discussed:
- Is the owner is an integral part of the running of the business?
- Is the business reliant on a small number of key stakeholders?
- Are profit margins very tight or consistently small than the industry average?
- Is team turnover high?
- Can the business prove that it is well run and thoroughly systemised?
- Does the business has long-term contracts that allow reasonable estimates of turnover and profit to be established?
- Are the accounts in order, and are all compliance requirements adhered to?
Any uncertainty or perceived uncertainty in the business will bring down the valuation.
Mixed Valuation
There may be a mixture of both profit multiple and asset valuation in the valuation of your business.
We assess assets that are owned by the business but will not be used in the business once the sale is complete, these can be sold separately. Many business owners don’t realise how much there is to consider here so speaking to a professional finance coach like me, or someone else is advised.
Increasing the value of your business
It takes around 5-10 years to prepare a business for sale, but the process can deliver two key benefits:
- An increased value, possibly as much as from 1x to 10x
- On the 5-10 year journey to sell, you will have more fun in your business and make more money.
So, going back to the key question ‘How to calculate the value of my business?’ Ultimately the value of your business is up to you. Put in the work to build a great business and you will be paid twice, once as you trade and again when you sell. Or sell now and take a lower price. The choice, as they say, is yours.
I’ve successfully assisted many business owners with their business valuation reviews and 5-year plans. Book a session with me here if you would like one too.
