Valuing your small business is a good idea for a variety of reasons, not only for selling. Learning how much your company is worth offers you a basis to build on and allows you to prepare for the future.
Once you know how much the business is worth, you can easily make an informed decision about whether buying or selling is worth the risk, and you’ll know if you’re overestimating the value of a business or risking being ripped off as a seller. Continue reading to understand how to assess the value of a business effectively. To get a proper valuation of your small business, follow these five steps.
Step 1: Get the Numbers Together
Although it may be tempting to start working with a business broker right away, the first step should be to organize the company’s financials.
Even if you work with a broker from the beginning, you’ll need to be able to tell them about the company’s earnings, assets, and obligations.
This should be simple if you’re valuing your own business and utilizing an accountant or bookkeeping software. They’ll most likely have all of the necessary information on hand, especially if they’ve been maintaining a balance sheet.
All of the different numbers are considered when valuing a business. Therefore you must obtain a report of everything. Profit margins, assets, loans, rentals, and even tax interest are all included.
Here is some information you will need to know:
- Annual income
- Money from sales
- Cost of goods
- Numbers from previous financial statements
- Numbers from previous tax returns
- Total expenses (including both recurring and non-recurring)
- Number of employees and their salary
- Any rental or building ownership information
These are only the fundamentals. Depending on the nature of the firm and how long it has been in operation, you may require additional or different information. Conduct some study in your sector to learn what other factors are typically used when appraising a similar firm.
The first step’s purpose is to ensure that you have a thorough knowledge of where the firm’s money and assets are so that you can begin to determine how valuable the company may be.
Step 2: Know Your Assets
The next stage is to analyze the assets that the company has to offer and what makes it interesting to a buyer.
You’ll need to take all of the information you’ve just gathered and try to calculate the value of the business based on the following:
- Assets
- Profits
- Projected Growth
- Interest
- Sales
If you understand all of the benefits and are purchasing, you will know how much the firm is worth, and if you are selling, you will be able to persuade a buyer to pay more. Another thing to consider is how successful the company has been in the long run.
Buyers look for three things in a business: safety, ROI, and strong growth potential.
Step 3: Evaluate the Risk
Once you’ve determined the assets of the company, you must consider the disadvantages and risks.
This can include:
- Operational costs
- Debts and loans
- Unstable growth
- Low-profit margins
- Poor economic conditions
Businesses that have been growing effectively for several years, with excellent profit margins and no debts, are far more appealing to potential purchasers and, as a result, have a much higher valuation. Once you’ve determined the assets and liabilities, you may proceed to the following step and begin valuing the company as a whole.
Step 4: Integrate Valuation Methods
There are several approaches to determining business valuation. While some are quite sophisticated and should be left to business brokers, there is a handful that anyone can do:
• The Book Method: To use this method, remove the obligations from the assets. You take all of the financial data you’ve extracted from a company’s assets and deduct the amount of risk or liability you computed while looking at the negative parts of the company. This will provide you with a number that shows how much the firm is currently worth. A buyer, on the other hand, is not just purchasing a business now; they are purchasing the prospective profits for the next few years. This is where the following method comes in.
• Earning Multipliers: This strategy is based on a company’s ability to continue producing money over time. This strategy is more concerned with the future and derives its value from how probable a firm is to continue producing a profit and developing consistently. This method measures the value based on the present earnings before interest and taxes (EBIT) multiplied by the potential for future earnings. So, if the liabilities and assets are valued at $100,000 and multiplied by a five-year multiplier, the business’s value is $500,000.
While these valuation approaches can be employed separately on occasion, it is preferable to combine both of them. This provides a much more complete picture of what a firm is worth now and what it will be worth in the future.
Step 5: Examine the Market Value
The next step in assessing a business is to examine its market value in relation to similar companies and what they sell for.
This is to assist purchasers in avoiding purchasing businesses and industries that are expected to fail or are underperforming due to a range of economic causes. It also protects sellers who are starting new firms in emerging industries from undervaluing themselves.
This phase is simple because it only requires you to be informed of the current market in your sector. The thing you need to be careful of is creating a fair comparison between other businesses and the one you’re appraising.
- Annual Revenue: Some brokers only work with enterprises worth more than $1 million.
- Whether You’re Selling Or Buying: Some brokers cater to sellers, while others specialize in assisting firms looking to sell.
- Experience: Some brokers will have more experience in specific industries, so look for one who works with businesses similar to yours.
A professional broker should be willing to have the talk and explain why they have those numbers. We went through the first five steps so that you are well-informed when speaking with a broker and can argue for the best deal.
You must read this article: Business Appraisal Benefits: How to Make the Most Out of It?
Final Thoughts
When purchasing or selling a business, knowing the value of the business is crucial to securing a favorable agreement. And, if it’s your own business, you can use it to acquire loans and investments, as well as calculate taxes.
Last but not least, we still recommend using a broker. Even if you can correctly value a business after reading this article, working with a professional and letting them find you the best bargain is still worthwhile.
