Financial market participants use business valuation to determine the price they are willing to pay or receive, to carry out the sale of a particular business.
Business valuation involves the estimation of the business about to be sold. This estimation includes the accurate price of the business plus the selling price the owner is going for. However, when it comes to business valuation, the inevitable and most important question is – How much is the business really worth?
There is no precise way to value a private business. The seller, of course, will want to drive the price up, while the buyer will want the exact opposite.
There are various ways to value parts of a business and calculating its importance. There are your tangible components like stock, fixed assets, land, machinery, equipment, etc. While intangible elements of the business that are also crucial in business valuation are ‘good will’, trademark and reputation --- all of which are difficult to value but are all important factors.
When looking at the overall value of a business, there are a number of different valuation methods which are commonly used. The common business valuation methods are:
Earning Multiples - This method is suitable for companies with an established financial history. In this method, the formula for computation is P/E which stands for Price/Earnings.
This ratio stands for the total Price of the business divided by the profits after taxes have been subtracted.
Entry Cost - This is the predicted cost to set up a similar business to that being sold. This includes the cost of developing a customer base, developing products and services, purchasing assets, recruitment, training and reputation
Asset Valuation - This method is applicable to companies with large amounts of tangible assets. The valuation is done by computing the realizable overall net value of assets.
Discounted Cash Flow – For this valuation method, the company under investigation is seen as having a lot of selling potential but with little financial history and assets to speak of.
This method makes a clear assessment of the overall estimation of the company’s cash flow.
Industry Valuations –This is the perfect valuation method for recruitment agencies and accountancy firms. The rule of thumb for business valuation depends on the current industry trend.
When calculating the value of a business, especially those of intangible elements, these valuation methods may be used:
Economic Climate – Obviously, buyers will be extra careful in buying a business most especially if there is an ongoing economic downturn.
Fixed Assets – defined as long term and tangible assets of the company such as manufacturing equipment, real estate, office furniture, etc. can not be converted to cash in the current or upcoming fiscal year. Usually, these assets can be sold and bought for a depreciated price.
Intangible Assets – this involves the company trademark, the kind of branding it has, its reputation, its key people, and the size and quality of its customer base are all important factors that determine the parts of the business and all of which do not reflect on the balance sheet.
However, tangible or not, a rapidly growing business is irresistible to buyers.
Reasons for Sale – For a quick sales, usually all valuation methods are discounted.
Reality – Experience dictates that any business, regardless of size, is only worth what someone is actually willing to pay for it. Though most likely business owners will get attached to the business and put it on a pedestal, industry conventions dictate that the true value of the company is lower than expected.
Before selling or buying a particular business, consult an accountant or financial adviser first. American Star Accounting Corporation is business to business experienced and understands business valuation. Our consultants and specialists on offering professional business valuation services.
For more information on the strategies, tips and how-to’s on expert business valuation advice, contact your American Star Accounting Corporation consultant now.
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