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How to accurately determine a business’ value before a sale or purchase

Posted by Tasnim Ahmed

July 20, 2021    |     5-minute read (951 words)

At some point, every entrepreneur or business owner will have the option to sell their venture. At times like these, it is vital to know how much your business is worth. 

This becomes even more important when it is a family-owned and operated business that has been inherited. Appraisals and valuations are two methods that help owners attain a clear and concise view of the business’ value. While the latter are required when you decide to sell, they also come in handy for various other purposes. For example, raising funds, making

There are many ways in which a business can be appraised. The most common are the income approach, asset driven approach, a market analysis, book value, market capitalization and the EBITDA method.

Why should you value your business?

There is a bevy of reasons why you should know the value of your company. A few important ones are listed below:

  • Your small firm is being sold to a third party.
  • Knowing the worth of your company might help you gauge its strengths and weaknesses.
  • Litigation (such as divorce proceedings).
  • When you're trying to raise money.
  • Required for an SBA loan.
  • Beneficial when it comes to estate planning. 
  • Helps if you choose to retire.

How do you value a business?

It's likely that business owners will require assistance for this. A chartered business valuator or broker who is familiar with business valuation methodologies can help you.
When it comes to selling a small business, you'll need to have some of the following items on hand -
  • A letter of intent.
  • A purchase agreement.
  • Buyer's due diligence with the letter of intent.

Gather your financial records

Financial records will play a part in determining the value of your company. Your business must create a list that includes the following items -

  • Profit and loss statements for the last 3 years.
  • Cash flow statements. 
  • Tax returns for two or three years. 
  • Distribution and supplier contracts.
  • An up-to-date balance sheet. 

Make a list of all your intangible assets

The intangible assets that a company owns add value to any business. For example, trademarks, patents, and copyrights.
  • Goodwill.
  • Copyrights. 
  • Patented technology. 
  • Different contracts and agreements (like license agreements and broadcasting permits)

Collect other important documents

Other important documents to consider when determining the worth of a company include financial and business statements like -
  • Forecasts and projections. 
  • Intellectual capital.
  • Tax returns. 
  • Organization documents and business plans.

The different methods of business valuation


  • Income approach: In this method a business’s valuation is assessed based on the answer to this question: “How much revenue or income can it generate in the future?” Usually, this entails two methods: Discounted cash flow and capitalization of earnings. In the discounted cash flow method, the present value of the cash flow of the company is forecasted and adjusted according to the risks entailed in its buyout. This normally is for businesses with high growth, however, which still haven’t broken even. 

  Capitalization of earnings is also used to determine a business’s worth by gauging its cash flow, its ROI and its value. The only difference between this and the discounted cash flow is that in the former, the forecast of profit is calculated to be the same that it is now when undergoing assessment. Capitalization of earning works best with businesses that are a few years old and that have a legitimate income and loss statement. Most internet-based businesses use the income approach, and by adding profit and loss a comprehensive valuation can be determined.
  • Asset method: A very common way to determine a business’s worth is to do an asset check valuation. It is plain and simple; the calculation and valuation of your tangible and intangible assets with the liabilities deducted. They are assessed, and a market value for them is derived. This is a great way for owners to know the value of their business, and also for knowing where spending is going. For a business that holds a lot of immovable objects, and even for companies with a lot of movable assets, this is a good way to assess business value.

  • Market analysis: This is an approach that bases its valuation on comparable businesses valuations. If, say, a company of the same nature of yours was sold recently, chances are that your company and business will be evaluated against that sale for purposes of drawing a relative valuation. This is one of the easiest ways to assign a to a business, but it is not a surefire way of getting the numbers correct. A lot of data is required to sufficiently get a working valuation, so this method works best for rapidly growing businesses.

  • Book value: This is one of the simplest methods of determining a value for your business. It involves taking all of your assets and collecting them -- tangible and intangible -- and then subtracting the liabilities that you owe. This is a great way for manufacturing businesses to get their valuations!

  • Market capitalization: Another straightforward business valuation process, but it only works for businesses listed on the stock market. Calculate the number of shares with the share price, and you will get the market capitalization and the market value of your company.

  • EBITDA process: EBITDA stands for Earnings before Interest, Taxes, Depreciation and Amortization. It is one of the most detailed ways to value your business, and it presents a clear picture to prospective buyers and owners alike. The EBITDA generally reflects the health of the business, its scope of work and capabilities. It showcases the value of the company by virtue of its financial performance. Balance sheet data and financial statements are required to calculate EBITDA for businesses.

 

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