If you are trying to buy a company, sell one, or are seeking new funding rounds, you will at some point have to know how to determine a business valuation. One of the ways to do so is by calculating the total value of your company’s worth. While there are few other methods of determining a company valuation, they all factor in things such as intangible and physical assets, the industry, earnings, and any losses or debt. In addition, since business valuations are estimates, the process may be just as much artsy as it is a science.
The most vital bit in a small-business valuation is an understanding of your market and industry and accurate reporting of figures. Critical paperwork including bank statements, financial statements, and deeds enable you to get the most precise valuation figures possible. With well-organized books, you stand a chance to offer more value to a potential buyer.
While you can undertake a small-business valuation all alone or by using an online calculator, you can as well hire a professional business analyst or broker.
Below Are Some Small Business Valuation Tips To Get Started
- Calculate The Business Owner’s Discretionary Earnings
Quite simply, discretionary earnings are the pretax income of a business before elements such as the owner’s salary, non-cash expenses, and one-off expenses are deducted. The tax return may provide an inaccurate figure of the total revenue grossed in by the company. Therefore, you should look at the SDE or seller’s discretionary income to have a more reliable view of the company’s profits and potential profits as well.
- Know Your SDE Multiplier
In addition to representing your business’ monetary value, the SDE multiplier compares your companies to others in a similar industry. The SDE sale value for most business generally ranges between one and four times their SDE. While sectors are assigned standard multiples, your business’ numbers may vary depending on the company size, assets, location, and others.
If you play a major role in contributing to your company’s success (or this is dependent on another individual), a buyer’s risk for success increases and in turn, your multiplier reduces. On the other side, though, if your industry is showing exponential growth potential, your multiplier will shoot up, and consequently, your small business will increase in value.
- Identify Your Market And Your Where You Fit In It
As a rule of thumb, always try to learn more about other same-sized companies in your industry. The capability to evaluate yourself to other businesses and having clarity on your place in the marketplace enables you to understand your value within an industry.
- Determine Your Assets And Liabilities
While it is important to get the necessary paperwork (including deeds and licenses) about your company before selling it or buying a new one, you also have to assess your liabilities, assets and revenue streams as well.
Assets are categorized into two: tangible and intangible assets. In addition, even if both are vital in determining your small business valuation, the intangible assets will affect the company valuation more. Hence, totaling all your assets while deducting liabilities is the first balance you will use to figure out your worth.
- Look Forward, Not Just Back
Remember to keep track of your business’ revenue generation. This will give potential buyers the impression that your company will keep growing and generating more income in the near future. Strive to add value by accurately outlining your business model and updating your business plan, so you give the buyers a better picture of your business operations and how they can help move it forward. In addition, you can grasp contracts slated for renewal, beef up promotions and marketing, and get letters of intent from key employees.
- Pay More Taxes
Although many entrepreneurs grapple with what they can write off during the tax season, it is actually better to report higher profits to the IRS. Paying more taxes indicates that your company is grossing in some good revenue, and this is a great way to prove to the potential buyers that your business is worth their shot. Some business analysts point out that every dollar of profit written off could cause the loss of two to three dollars in the business valuation.
- Consider getting professional help
Everyone can do a simple calculation or use an online calculator to estimate the value of their small business. Regardless though, there is much more value in hiring a professional broker or appraiser since this can come along with some impressive benefits. Unlike novices, professionals will conduct an in-depth audit of your company and prepare a business valuation that is specifically tailored for your industry and region. In addition, a buyer will hardly negotiate against an authentic professional assessment.
How To Determine A Small- Business Valuation
While there is no legal or official definition for determining a business valuation, it is to some extent, a subjective calculation. There are three basic types of tests, and four methods used in calculating the right company valuation. Each calculation uses assets, income, or market comparisons to create a valuation. Remember that consistency and accuracy go hand in hand. Do not combine formulas, but rather, try all of them and select the equation that best suits your small business. Below are your options:
∙ Income Approach
The income approach is segmented into two methods. They both show the future income a small business can generate.
.Firstly, the discounted cash-flow method assesses the current value of business’ future cash flow that is adjusted for risk linked to purchasing the business. New companies with excellent growth potential are a great fit for this method.
.Secondly, the capitalization of earnings method determines today’s value of a business by viewing the projected future benefits as well as the expected return rates. Typically, this method is ideal for established businesses with steady cash flow.