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Value Business FAQ's

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Value a Business FAQs

What do you need to know when valuing a profitable business?

When valuing a profitable business you only need two things:
1. The accurate profit of the business and
2. the number to multiply that profit by
It is as simple as that

When valuing a business that is not profitable it is worth asset-value only
There are many asset valuation methods

What is the Asset Valuation Method?

Asset Valuation is one of the methods used when valuing a business on its assets and includes:

  • Liquidation value – what you could sell the assets for immediately
  • Going concern value – value of the assets installed, in situ, attracting greater value for the fact that they are installed, operational, and in many cases utilities connected.
  • Depreciated value– value of assets after allowance for legal depreciation under local tax laws
When do you use the Income/Profit method?

When using the Income/Profit method, be careful when trying to arrive at what the income is. There are many definitions of income

  1. You either work with profit including owners wage or profit after owners wage has been deducted. The multiplier changes according to which income you are working with
  2. If you are using the profit after owners wage has been deducted, the multiple will be larger. This is where many people go wrong
Do you value goodwill separately?

When valuing a business using one of the income methods, don’t value goodwill separately. Goodwill is just the difference between the value of the assets and the value of the business.

Business Value = Goodwill + Asset Value.

It’s a simple equation

This means that you value the total business, then analyse the separate components of the business.

What are the three main things that affect business value

The three main things that affect business value are profitability, maintainability of profit and transferability of profit.  Unless you have all of these, you won’t have much value in the business.

  • Key to business value – profitability
    When valuing a business according to its income, there needs to be at least some profitability
    If the business has no profit, it only has asset value.
    The profit must be visible and provable, not just arguable
  • Key to business value – maintainability
    A business has some value if the income is likely to be maintained into the future
    It doesn’t matter that the business made a lot of money last year, if the prospects for the future are bleak
    Maintainability takes into account threat from disruption, fashions and trends and other threats
  • Key to business value – transferability
    A business has no value if the income of the business can’t be transferred to another person
    If the income is tied to the current owner there is no value to be transferred
Is valuing a business fixed

Valuing a business is not a static thing. Business value changes from month to month and quarter to quarter. Fortunes of the business fluctuate along with changes in the industry and the economy
Usually the most up-to-date information is the most reliable when it comes to evidence upon which you are going to base a business valuation.

How many Business Valuation methods can you use at the one time?

You can use any method in combination with any other method as long as they are relevant. You will often see the income method combined with the market method and compared to the rule of thumb method. This is valid.

It is allowable to average the results found by the different methods or to weight one method over the other if that is appropriate.

How does valuing a business with the Rule of Thumb work?

Valuing a business according to the Rule of Thumb Method values a business according to recognised metrics other than the profit metric eg

  • You might see a real estate agency valued on its property management total revenue
  • You might see a mortgage broking business valued as a multiple of its income trail

It is often seen as a quick and ready way of valuing a business and for this reason is sometimes discredited. You won’t see business valuers totally relying on the Rule of Thumb method.  It could be used as a cross check against one of the other more scientific methods.

What is market Method?

Valuing a business according to the Market Method pays attention to other sales in the marketplace of comparable businesses
The more data you have about comparable sales, the more valuable is this method as a good valuer should always check a valuation opinion against actual sales in the marketplace of similar businesses.

This at least gives you the range of multiples. In other words, the market approach to business valuation is rooted in the economic principle of competition: that in a free market the supply and demand forces will drive the price of business assets to a certain equilibrium. Buyers would not pay more for the business, and the sellers will not accept less than the price of a comparable business enterprise. It is similar in many respects to the “comparable sales” method that is commonly used in real estate business.

No two businesses are alike, however, The Market Method is at its most reliable when providing you with a range of values from which you may choose one

What is the Cost to Create Method?

Valuing a business according to the Cost to Create method values a business according to what it would cost to start the business and bring it to its current stage.

The costs you bring in include establishment, by materials and equipment, leasing, staff recruitment, marketing and other costs.  This is a useful method since many people look at the alternative of creating their own business instead of buying someone else’s

What is the Discounted Cash Flow method?

Valuing a business according to the Discounted Cash Flow method is used when there are cash surpluses or the reasonable anticipation of cash surpluses into the future.

This method only measures cash in and cash out and calculates the difference.  If there are cash flow surpluses in the future, the value of those surpluses are valued in today’s dollars to give us today’s valuation figure.  It takes into account all future costs, including capital costs.

In other words, to know the present value of your business, all the future expected cash flow associated with cash flow are discounted so as to arrive at its value at today. Discounted cash flow is based on time value of money because a dollar today is worth more than a dollar in a year’s time and even more than a dollar in two year’s time.

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