Business valuation is the process of determining the economic value of a business or company. It involves analyzing various factors and methods to estimate the worth of a business, which is essential for various purposes such as buying or selling a business, securing financing, mergers and acquisitions, tax planning, and legal disputes. At BBA, we can prepare for you business valuations following the methods described below. For large transactions, we recommend the use of a third party business valuation service, since these type of valuations are typically pre-qualified for SBA loans and some traditional lending financing.
The valuation of a business takes into account both quantitative and qualitative aspects. Quantitative factors include financial statements, cash flow, revenue, assets, liabilities, and growth potential. Qualitative factors include market conditions, industry trends, competition, management expertise, and intangible assets like brand value and intellectual property.
There are several commonly used methods for business valuation, including:
Market Approach
This method compares the business to similar businesses that have recently been sold. It involves analyzing the market data and determining a value based on the prices of comparable companies. At BBA, we have access to extensive data on businesses sold during the last year and earlier (normally a year is sufficient).
Income Approach
This method determines the value of a business based on its expected future income or cash flow. It involves estimating future revenue and expenses and discounting them to their present value. Our added experience on accounting and taxation supports cash flow forecasts and pro forma documentation.
Asset Approach
This method determines the value of a business based on its net asset value. It involves assessing the value of the company’s tangible and intangible assets, deducting liabilities, and arriving at the net asset value. This method is more suitable with situations where the owner of a business has a need to dispose of the business quickly, obtaining only the value of FF & E and related assets.
Cost Approach
This method calculates the value of a business by estimating the cost to recreate or replace the company’s assets. It considers the cost of acquiring similar assets and adjusting for depreciation and obsolescence.
Times Revenue Method
Under the times revenue business valuation method, a stream of revenues generated over a certain period of time is applied to a multiplier which depends on the industry and economic environment. For example, a tech company may be valued at 3x revenue, while a service firm may be valued at 0.5x revenue.
Earnings Multiplier
Instead of the times revenue method, the earnings multiplier may be used to get a more accurate picture of the real value of a company, since a company’s profits are a more reliable indicator of its financial success than sales revenue is. The earnings multiplier adjusts future profits against cash flow that could be invested at the current interest rate over the same period of time. In other words, it adjusts the current P/E ratio to account for current interest rates.
The choice of valuation method depends on various factors, including the nature of the business, industry dynamics, availability of data, and the purpose of the valuation. Each situation is unique. A critical factor is the actual amount of profit, cash flow that the owner has derived from the business in a particular period of time.
It’s important to note that business valuation is not an exact science and involves subjective judgment. Different methods can yield different values, and it is often necessary to consider multiple approaches to arrive at a reasonable valuation. Additionally, external factors such as market conditions and economic trends can also impact the value of a business.
A business broker can provide significant support when it comes to the valuation of the business.
