How to calculate business valuation
Many business owners or aspiring business owners have wondered at some point in their career how to calculate business valuation. Usually the question arises when one intends on buying an already existing business instead of starting one from scratch, thinking of selling their business to someone else, or needs to attract investors or to borrow money.
However, many people find out to their surprise that to calculate business valuation, the business valuation professional has to apply a great deal of judgment and use numerous assumptions. The final product of a business valuation is not an exact number but rather a range of values at which a business could be bought or sold by a reasonable party.
In other words, a business valuation cannot be calculated down to an exact number that is the ultimate and undisputed price of the business being valued. If this would be the case, then the question of how to calculate business valuation should be changed to how to produce the most realistic estimate of a business’ economic value.
There are a few methods to calculate business valuation that when combined with each other can produce an estimated range that is both realistic and accurate.
Below we discuss the most widely accepted methods on how to calculate business valuation.
- Asset-based valuation. One way to estimate a business economic value is simply to add up all the assets of the company and subtract its liabilities. Assets include both tangibles such as land, buildings and equipment and intangibles such as trademark, patents, goodwill and copyrights. Liabilities include loans, bonds, accounts payable and any tax liabilities. Usually the values of assets and liabilities are derived directly from the most recent balance sheet but can be adjusted to market or liquidation value depending on the circumstances.
- Multiples-based valuation. Business value can be estimated by determining how much revenue or earnings before interest, tax, depreciation and amortization (EBITDA) a business makes on an annual basis. Then, the company’s value can be estimated as a multiple of this figure by comparing it to a group of publicly traded peers or other similar companies for which this information is available.
- Capitalization of earnings. This method involves determining the normalized rate of earnings for a business going forward and then dividing it by the capitalization rate. Here, the most important step is choosing a capitalization rate that is appropriate for the risk associated with the business that is subject to valuation.
- Discounted cash-flow analysis. This method uses the sum of all future free cash flows, discounted by the cost of capital, to get a current value. The present value is an income stream’s value at the time of its valuation. Here, there are two important elements: the discount rate, that has to be chosen to capture the risk associated with these future cash flows, and the growth rate or rates, that are used in determining the future cash flows.
- Comparable transactions analysis. A business is more than its financial statements and it often has value that lies with its relationships with employees, customers, suppliers or with intellectual property that has been created. Some businesses might not have profits or even revenue but that does not mean that they do not have value. In this case, the valuation professional can factor in the price at which similar businesses are sold.
Contact us, your business attorney in Miami, Florida USA if you need advice on retaining a suitable business valuation services firm.
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