Your business is likely your largest asset. But do you know what it’s actually worth?
Whether you’re planning on selling in the near future or not, it’s important to have an understanding of your business’s valuation. Not just because it’s nice to know, but because it’s always good to be prepared with all the facts.
So how do you put a price tag on your business? Unfortunately, valuation is not an exact science as it’s based on assumptions as well as financial information.
The most basic way to value your business is to take your hard assets and subtract your debts. All of this information can be extracted from past accounting reports. From them you can glean your net income (after deducting a reasonable salary for yourself if you work in the business), expenses, the value of your property and/or inventory and any liabilities or debts you may have.
A standard multiplier is then used to multiply all of this – a rule of thumb that varies from industry to industry. The best way to determine your multiplier is to research the selling price of businesses similar to yours.
This valuation method is usually deemed the most accurate and is the most effective way to estimate the value of a business because it’s based on cash flows. These figures reflect the amount of money that is assumed to come into the business annually and therefore determines an investor’s return on investment.
Here’s where the inexact science comes in: if your cash flow is rising year over year, the value of your business goes up. But if it is falling, or is in flux year over year, the value of your business may go down. A business with a steadily rising cash flow may be able to value their business at 10 times last year’s returns. But a business with a steadily decreasing cash flow may only be able to value their business at five times last year’s returns. After all, potential buyers are concerned about their ROI.
The most important thing to remember when determining a business valuation is that regardless of what you deem your business to be worth, its value is in the eye of the beholder – it’s actually only worth what someone is willing to pay for it.