What's my business worth? If you're not asking this question, it's challenging to identify ways to increase its value over time. A business valuation helps you determine your company's worth, assess risks, and develop a financial strategy. Small business owners complete valuations before selling, during exit strategy planning, or when looking for funding.
You can calculate your business's value using various valuation methods, depending on your industry, available data, and the valuation's purpose. To find out what your company is worth, explore business valuation methods, the steps for calculating your company's value, and how industry trends and other factors impact valuations.
Business valuation methods for calculating your company's worth
To select the best valuation method, it's vital to understand the differences between each business valuation formula. The information below explores the differences between asset, income, and market-based approaches.
Market method: Estimate business value quickly
The market approach compares your business to similar companies that recently sold. In Forbes, business broker and appraiser Trent Lee called the market method a five-minute business valuation because it's a straightforward way to estimate a company's value and is less complex than other methods that require forecasting future revenue.
This system uses the seller's discretionary earnings (SDE) and a market multiple. According to the Corporate Finance Institute (CFI), SDE includes EBITDA (earnings before interest, taxes, depreciation, and amortization), one-time expenses, nonrelated business expenses or income, and adjusted expenses.
Lee uses the market multiple of 2.28 based on BizBuySell data, which comes from analyzing actual business sales transactions. The multiple varies by industry, business size, and financial health, making it vital for business owners to research industry-specific benchmarks before applying them to their company valuation. You can check sales listings on BizBuySell.com and use the business valuation report for further details.
Multiply your SDE with the average market multiple for a quick business valuation. The result is your estimated fair market valuation. Lee recommends working with a mergers and acquisition specialist or business broker with a certified business intermediary (CBI) designation. These individuals can provide an accurate average market multiple.
Asset-based approach: Calculate your worth
Like the market method, the asset-based formula, also known as the book method, is relatively simple. It computes the difference between your assets and liabilities using data from your accounting records. Small businesses may use this method for a lower business valuation, such as for tax purposes. Although this approach is straightforward, it may not capture the full value of your intangible assets.
Find out what your business is worth by tallying the sum of your business assets, including equipment, real estate, and inventory. Then do the same for liabilities, which are outstanding loans and debts. Subtract liabilities from your assets to get the book value of your business.
Income method: Base value on future cash flows
You can use two income-based business valuation methods to calculate your company's worth. The discounted cash flow (DCF) analysis estimates future cash flows and discounts them to determine their present value. The capitalization of earnings method divides your expected earnings by a capitalization rate, making it a better option for companies with stable revenue streams.
A DCF analysis requires you to forecast future cash flows and the end values of assets and investments. You must also choose a discount rate that is affected by your company's risk profile and capital market conditions.
You can predict cash flows if your company has historical financial data. However, this method is trickier for startups that lack cash flow and financial records. A spreadsheet or financial calculator is less complicated than a manual computation. Since the accuracy of your valuation depends on your cash flow forecasting ability, you may want to work with a professional.
A business valuation helps you determine your company's worth, assess risks, and develop a financial strategy.
How industry trends can impact your business valuation
Consumer demand, technological advancements, regulatory changes, and economic conditions affect the growth potential of your industry. These factors also impact your risk profile, profitability, and business valuation.
Small businesses in rapidly growing sectors could command higher valuations due to anticipated future earnings, whereas those in declining industries could see their valuations decrease. Consider the shift in retail from brick-and-mortar to e-commerce.
When Amazon revolutionized the industry with convenient customer options, traditional retailers like Target and Walmart followed suit to maintain competitiveness and protect their valuation. Conversely, Sears and JCPenney were slower in transitioning. Companies that adapted to online sales maintained or increased their value, whereas others saw their market presence and valuation decline.
Key factors that can drive up your business's worth
If you want to prepare your business for acquisition or make it look more attractive to investors, consider the factors that increase your business value. You can drive up your business's worth by evaluating these elements and developing high-impact strategies.
Here are a few key factors that can enhance the value of your company:
- Strong financial performance: Maintaining healthy profit margins and consistent revenue growth demonstrate stability. Calculate your business's financial health and set revenue goals.
- Diverse customer base: Having a broad customer base is less risky than relying on one segment. Assess your client list and consider increasing your outreach efforts.
- Unique value proposition: Offering bespoke products or services can differentiate your brand and increase its value. Review your sales strategy to identify opportunities.
- Efficient operations: Controlling costs and streamlining operations can improve your profitability. Consider using automation and artificial intelligence to enhance efficiency.
- Scalability: Flexible, agile companies that can expand their operations without huge costs can be worth more. Map internal processes and add business automation to improve scalability.
Steps to conduct a DIY business valuation
Use financial statements and a valuation method to determine your company's worth.
Accounting software with financial reporting tools can streamline the following steps for conducting a business valuation:
- Gather financial statements. Collect at least three years of balance sheets, cash flow, and income statements.
- Choose a valuation method. Decide whether the asset-based, market-based, or income-based approach is most relevant to your industry and business type.
- Calculate owner's discretionary earnings. Adjust your net income by adding back your compensation, personal expenses, and nonessential costs to show the true earning potential of your company.
- Apply a multiple. Use industry reports or financial benchmarking tools to find typical valuation multiples within your industry and select a multiplier.
- Assess intangible assets. Consider how customer loyalty, intellectual property, branding, and operational efficiencies could affect your business valuation.
- Evaluate market conditions. Look at current economic trends, competitor performance, and consumer demand.
A DIY business valuation provides a rough estimate but may not give you a complete picture of your company's true value. A professional business valuation is more accurate and credible if you're preparing for a sale, have legal issues, or are seeking investors.
Why use a business valuation calculator
Consider using an online business valuation calculator to avoid manual formulas or Excel spreadsheet computations. These tools are easy to use, and most don't require registration. Simply input your details to get a quick estimate of what your business is worth.
When to work with a professional for business valuations
If you ask individuals or firms to invest in your company or lend money, you may need a formal business valuation. The American Institute of Certified Public Accountants (AICPA) provides Accredited in Business (ABV) certifications to CPAs who meet minimum standards and pass an exam. Search the American Society of Appraisers (ASA) database to find a qualified business valuation expert.
If you're seeking capital either through investors or lenders or are involved in a lawsuit, you may require the services of a business valuation expert.
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