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The Importance of Business Valuation

To you, the value of your business is the blood, sweat, and tears you’ve put into its success. A formal business valuation puts that hard work into an analysis potential buyers, partners, and investors can understand. Learn the best methods for conducting a business valuation and how to know when your company needs one. 

What is a business valuation?

In short, a business valuation is the process of determining your company’s fair, economic value. It’s a comprehensive analysis of all areas, departments, and structures, pinning down the current worth of the whole and its parts. 

What will a valuation tell me about my business?

In practice, a business valuation can help companies discover:

  • Departments low in profit.
  • Their overall sales value. 
  • Ways to improve the business structure.
  • Resolutions for internal disputes. 
  • Tax planning techniques . 
  • Approximate measurements of growth and revenue over time. 

Valuation information is also integral for major decisions. Whether preparing for a merger or future expansion, you can’t work toward the best outcome without knowing your company’s quantified value.

What factors contribute to a business’s valuation?

Different valuation approaches evaluate different factors. However, there are some commonalities to consider. In general, valuation may be affected by your company’s: 

  • Recent transactions. 
  • Industry ratios.
  • Management structure.
  • Forecasted revenue growth. 
  • Capital structure.
  • Financial statements.
  • Patterns of shareholder payout. 
  • Assets and their market value.
  • Overall industry trends. 

What types of business valuations are there?

There are a myriad of business valuation methods, and it’s up to you to determine which most accurately reflects your practices and financial situation. Most methods fall into three categories.

Income approach

The income approach to business valuation focuses on the company’s anticipated revenue. Value is determined via future profit or cash flow. 

The discounted cash flow (DCF) method is just one example of this. It translates cash flow projections into the company’s current market value using the discount rate and time period. 

Terminal Cash Flow / (1 + Cost of Capital) x Number of Years in the Future

The major benefit of the DCF method is that it can demonstrate a company’s production of liquid assets. However, it relies on often fluctuating values. 

Another income approach is the times revenue method. It measures revenue generated over a period of time with a multiplier dependent on the industry. 

Asset Approach

The asset approach calculates overall asset value for companies with more physical than intangible assets. This approach often isn’t used as many businesses prefer valuation based on future earnings or overall value. 

Asset approach methods include:

  • Book value — A calculation of tangible assets produced by taking a company’s overall assets and subtracting liabilities and intangible assets 
  • Liquidation value — A calculation representing the cash amount a business would have left after liquidating all assets and paying all liabilities
  • Adjusted net asset method — A calculation that accounts for the fair market value of assets and liabilities 

Market Approach

Market approaches take the entire industry into account by comparing your company with those similar. This typically involves looking at a company’s revenue or their earnings before interest, taxes, depreciation and amortization (EBITDA). 

Comparable company analysis is one such method. Using calculated ratios of enterprise value and revenue or enterprise value and EBITDA, you can compare your company with others similar in size and location to determine value. Precedent transaction analysis is an alternative method using comparable companies recently sold. 

When do I need a business valuation?

One of the best opportunities for a business valuation is succession planning. A valuation highlights your business’s successes and struggles. As a plan is developed, management structures can be built around supporting what’s working and targeting what’s not. 

In that same vein, a business valuation provides key information for any major — or minor — business decision. It’s like knowing all the cards in your hands before you place a bet. Some prime occasions include:

  • Selling the company
  • A merger or acquisition
  • Tax reporting 
  • A change in partners
  • Related divorce proceedings 
  • Bankruptcy or litigation 
  • Applying for financing 
  • Insuring the business 

Even if none of these situations apply to you, an annual business valuation tracks progress and assists with strategic planning. 

The only time a business valuation won’t help is when done incorrectly. By teaming up with a qualified financial professional for your business valuation, you’re not only ensuring correct information, you’re utilizing years of experience. Whether you’re looking to raise capital or seek financing, at SME CPA, our team can conduct, interpret, and apply your business valuation to whatever next step comes your way.

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