Business Article - Valuing Your Business
The decision to sell your business may have been a difficult one, but the process that follows is often far more stressing. Most businesses are the by-product of a passionate owner who invested much time and resources into the company. The first reaction will be to charge a price that seems fair for all the work and effort put into the business. However, this usually results in the inability to sell. Other companies or prospective buyers do not care about paying you for your past effort. They simply wish to buy a good business at the best price possible.
Most prospective buyers will approach you with negotiations, so prices are rarely set in stone. However, negotiations cannot happen without a starting price. Pricing too high may result in buyers assuming that you aren't willing to go as low as they would like and persuade them not to make an offer. Likewise, offering a price that is lower may result in negotiations that drop far below what you are willing to accept. Have a general figure in mind is less stressful when selling your business; you will be more open to the figures buyers are prepared to pay, and will reduce disappointment in the final sale.
Rule of Thumb Method
Often referred to as the 'rule of thumb method' , this is the most common means of valuing your business. The value of your business is determined according to the business standard for the that specific industry. Every industry has its value determined by benchmarks set in that industry. While a common and generally good method, it does have it down side. The benchmarks used are generally based on the current industry averages; benchmarks do not consider the individual circumstances of your specific business. If you are looking for a way to average your company so that negotiations can take place, the 'rule of thumb method' is ideal. Otherwise, there are other, more satisfying means of valuing your business.
Determine its Market Value
The market value of a business or company estimates the direct value of an individual company based on its current market industry. Using the market value method to determine the set price for your company is fairly common and is usually the first figure determined when valuing a business.The market value of your company will be based on a series of figures and calculations determined by both the business itself and the current market trends. Once a figure has been determined, comparing it to other businesses of similar status in the same industry will be useful in deciding if the price is fair.
Before making the calculations on your business, the type of income figure you use will need to be determined and used for all the companies involved. If you aren't going to compare it to other companies, however, this step can be skipped.
An example of comparison calculations follows: the figure can be based on gross income, net income, gross of net income + inventory, etc. No matter what income basis used, the key for accuracy is to use that same figure for the comparison businesses. Comparing one market value price based on gross income will have incorrect results when compared to a different business who market value is determined by gross income + inventory.
The market value is derived via the multiplication of an industry multiplier to the sales figure used. So, for example, if the industry multiplier is currently .25 and the income figure is £150,000, the market value will be determined as £37,500.
The industry multiplier varies over time. The most current one can be determined by contacting a business appraiser. There are some suggested rough figures for the multiplier based on the industry the business falls under. For example, a retail business will usually have a multiplier between .75 and 1.5. However, these figures are usually never ideal, and the actual multiplier may vary greatly.
The problem with using market value is that it does not take into consideration the value of the one specific business within its industry. Your business within your specific market industry by be worth substantially more or less than the general figure indicates. Because of this reason, it's usually best to use the Market Value as nothing more than a generic idea of where your business sits value-wise.
Capitalized Earnings
Your company at this point should have a current amount of monthly profit (income). Using this method, income capitalization is based on the predetermined annual return rate necessary for taking on the new business; this method of valuing in no way accounts for tangibles. In contrast, however, capitalization takes into account a load of intangibles, which may be of better benefit to your company.Return rates vary, depending on the risk involved; however, there are general guidelines used to estimate the amount. Small business owners, for example, are usually expected to have a minimum 20% return rate annually on their investment. The return rate is often referred to as a multiplier. The multiplier can be determined by contacting an appraiser. Essentially, the business value is directly correlated to the size of the investment required to earn the return rate needed. It sounds confusing, but a skilled accountant or business finance manager will be able to offer an amount that is suitable for your company.
To calculate the capitalized earnings, simply take the anticipated earnings and divide it by the capitalization rate.
Tangible Assets
This method is not used nearly as often as the other methods. However, there are times when the worth of a business is decided only by the value of its tangible assets. This applies especially for companies such as factories where the majority is composed of large number of expensive equipment. Other tangibles include items that can be seen, or physically handled. Equipment or machinery, real estate, vehicles, computers, or other similar items are all considered tangible assets.One method of determining the value based on tangibles is to calculate their fair market price, also known as FMV or FM. The other, more accurate method is to calculate how much it would cost to purchase the items. For example, if there is X number of machines, and they are all relatively the same in age and condition, how much would it cost to purchase those assets?
Intangibles Value
Internet businesses, often referred to as 'dot com companies', use intangible value to determine the value of the business. Due to the nature of the Internet, many dot com's have very little or no tangibles. For some, intangible valuation may be the only evaluation option available.Things like customer base and the number of long term customers retained are usually the main intangible analysed when the potential purchase of a company is analysed.
Owner Benefits Value
If your company is viewed solely on its ability to generate cash, than this method is probably the best. For companies like this, tangible assets are not important. If the company needs to generate cash and does so consistently and in high amounts, it is considered a good company and will automatically be worth more. However, a business that fails to generate a substantial amount of money, or that has a variable amount of earnings monthly, is generally considered to be worth less and often ranked lower.This method of valuing is the most simple, and requires no market research or income assessments. In order to determine the worth of this company, simply multiply the owners benefit with the number 2.2727. The resulting figure is the market value, or estimated value of the company.
Return on Investment
What is the return on investment for your business? The return on investment is often used, even though it takes little other aspects of the business into consideration. The return on investment is the correlation between the amount of money spent on monthly expenses, and the amount of money earned. A company that earns in excess of 15% on their money investment is considered to be a good choice.Determining the value of your company or business can be done alone, without the aid of a professional. However, unless you are an industry expert, the final figures may be too high or too low, and the resulting sales skewed against you. A professional will be able to analyse the current industry, recent sales, the profit margins of your business, and several other factors to offer a decent price within a more general price bracket. There are many methods to determining the value of your business. Each method is unique and will result in a different figure. If you are unsure of how to proceed with the calculations, contacting a professional will likely be the best move. Incorrectly determining the value of your business could result in a price to high, which will turn away most prospective buyers, or a price too low, which would cause a substantial loss on your business.