How to value a business

How to value a business

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Are you considering getting a valuation for your business? We realise that there are different reasons for undertaking such a venture. But for us as business brokers, a business valuation often precedes one thing – the sale of the business. If that is your situation, you need to ensure that you can get an accurate valuation – this holds for any of the possible reasons you might have for needing a valuation.

What then is the next step? You need knowledge. You must understand the basic approaches and principles if you wish to end up with an accurate value for the business. That is precisely what we are here to help you with.

In this article, we are going to be covering a broad spectrum of practical information for you on the process of doing a business valuation. We are not just going to stop at outlining the process of doing a business valuation. We will provide practical tips to help you increase the value of your business in preparation for a sale. Let’s get started, shall we?

Looking for a handy checklist that will walk you through all that’s needed when preparing your business for sale? We’ve created one with all you need – and you can download it here.

Why you may need to get a business valuation done

As a business owner heavily invested in your business, you most likely know all that is possible about your business, particularly in terms of its strengths and weaknesses. 

However, without a business valuation, you are one step shy of knowing all there is to know about the business.

Why is such knowledge crucial, you ask? It all depends on the next phase you want your business to go into. This could be one (or more) of the following:

  • Asset Protection
  • Investment
  • Entering a New Growth Stage
  • Exit Planning and business sale: this is usually the primary reason for undertaking a business valuation. When planning your exit from the business, you ideally hope to sell your business for a figure that will provide the kind of exit you desire. You may be looking for an external buyer or may intend to sell to the employees; regardless of the eventual buyer, an objective valuation helps you set a fair selling price.

Furthermore, with the valuation details, you would know if it is in your best interests to work to increase the value of the business before finally selling – this article outlines the factors that will help you improve your business value. After all, you want to exit from the business successfully in a way that meets your goals. You can also check out our guidebook for more steps to add value to your business.

How to value a business – methods, approaches and formulas

As we mentioned earlier, you need a good amount of quite specific knowledge to embark on a business valuation. Even if you are calling in an expert for the job, it is usually helpful to be able to follow through the process. In this section, we will highlight the steps in doing the valuation.

Approaches to business valuation

Let’s start with the approach. This determines the broad mindset with which you look at the valuation, and there are four.

Income approach

Here, you are looking to evaluate the business and the prospects of the future income it can generate. This approach is informed because buyers are often interested in the potential profits the company can make for them after they take it over. So, if you believe the business has significant growth potential and you want to sell based on that potential, this is a good approach.

Market approach

In this approach, you want to determine your company’s value based on what similar companies fetched during their sale. You evaluate previous sales in your niche to help find a benchmark price.

Asset-based approach

This is similar to taking a sum of the values of the parts (assets) making up the business. You might decide on this approach if you operate in a capital-intensive industry. It also becomes useful if you realise that the company can only grow minimally in the future.

Cultural approach

This cultural approach involves a combination of the hard mathematics of business valuation with intangible elements. In this approach, staff motivation, knowledge, and business culture are usually incorporated in the determination.

With these approaches in mind, we can then explain the actual methods to be deployed.

Methods of business valuation

There are many methods of undertaking a business valuation. Several factors, such as the size of the business and the circumstances surrounding the sale, influence the choice of methods used.

Entry cost

This method attempts to evaluate the business by estimating how much a potential buyer would otherwise spend to establish a similar business. 

In doing this, the final amount often takes into consideration the following factors: staff, premises, training, capital, equipment, stock, and customers. The time it will take to build a new business to the same level as the one for sale is also considered.

Entry cost calculation

However, this does not mean that each business element has to be accounted for singly. You should rather do it holistically. One vital element though is the customer base. Using this method, you must ensure to factor in the marketing costs needed to build up a customer base.

Price-to-earnings (P/E) ratio

This method primarily uses the business profits (after tax) to determine the business value. It is usually done by multiplying the most recent year’s post-tax profits by a ratio applicable to your business and industry. This ratio is usually determined by the size of your business and the market in which you operate.

Companies with publicly traded shares are commonly evaluated using this method. But this does not mean it does not apply to private businesses. The P/E ratio (also called multiplier) is usually a number between 2.5 and 10, with privately held companies tending to use a lower multiplier than the public ones.

Rule of thumb valuation

This is also known as turnover valuation. It is regarded as an informal method, as it values your business based on your sales revenue. Sectors that use this method usually have costs and gross margins estimated to be the same.

When would you use this method? If you have not completed a full year of trading, this may be an appropriate method to use to value your business, as you cannot use the annual accounts to confirm the profits you have made. 

Similarly, companies use this method to obtain a ballpark figure of their value if there is an urgent need for it. You can learn more about the turnover valuation method if this method appeals to you.

Other business valuation methods include the Net Book Valuation, EBITDA Multiple, Discounted Cash Flow and the X-Factor Value. Read this article on business valuation methods for more insights on these methods.

How to increase the value of your business

Regardless of the purpose for seeking a business valuation, a good business value will always yield dividends for you. Whether you seek investment or are looking to sell and exit the business, you will get a better offer with a highly valued company.

This then begs the question: how can you increase the value of your business? There are many ways to improve your business valuation. Before we head into that, you should consider this business value growth consulting framework

It helps you build a high-performing business, and the tips in the framework will guide you in increasing the value of your business.

Now, here are some strategies that you can deploy to increase your business valuation.

Develop a robust financial record keeping system

Beyond the figure your business valuation efforts yield, the true worth of your business is what buyers are willing to pay for it. With this in mind, it is possible to increase your business value by engaging in relatively simple book-keeping, particularly as it relates to your financial records.

Keeping an adequate financial record involves formalising those records by using available technology to make the information easy to store and retrieve.

When a prospective buyer asks about the company’s finances, you want to be able to present them at the push of a button. 

Beyond being easily accessible, the records should be accurate enough to produce a true picture of the business’s financial status.

For more insight on this, read this article explaining the elements of a robust financial record-keeping system.

Maintain proper cash flow management

Another way to ensure an increase in the value of your business is to manage your cash flow. First of all, cash flow refers to the inflows and outflows of money in your enterprise. Cash flow moves both ways and so can be positive or negative. It also affects all aspects of the business.

Your cash flow determines the working capital available to the business. Proper cash flow management eventually translates to better working capital, which is a considerable determinant of how your business valuation and eventual sale will go.

Buyers often have budgets that account for the working capital needed to help them coast through the first months of newly owning the business. 

The better you can manage the cash flow to minimise the capital requirements, the more the company is valued as the buyer will be willing to offer you a higher sale price within their budget. A conscious business owner will use cash flow management to increase their business value.

Increase customer satisfaction

When discussing a business valuation, it is easy to get preoccupied with the impacts of revenues and profit and fail to consider other factors. However, you should not make the mistake of underestimating your customer satisfaction and its impact on your valuation

As we mentioned earlier, customers are central to the health of your business. Without them, there are no revenues and no profits.

Customer satisfaction

After obtaining your customer’s patronage, ensuring that the customers are satisfied is an entirely different task. An unsatisfied customer is unlikely to tell you about their dissatisfaction; they simply stop using your services. This means that tracking customer satisfaction levels is essential.

By doing this, you have happier customers who are more loyal, and consequently, your business retains them. Since it is more cost-effective to keep a customer than to convert a new one, increased customer retention makes your business more valuable.

Secure continued customer patronage

It is often said that the customer is the lifeblood of any business. Without your customers, you will not have any sales to post, which does no good for your bottom line. 

On the other hand, the ability to keep your customers coming back to deal in business with you is a plus for any business. The customer base of your company forms a significant part when undertaking a business valuation, so it is essential to be able to lock customers in.

However, keeping customers coming back to your business does not come easy. These six strategies are helpful to retain your best customers and keep them coming back, and by doing so, increase the value of your business.

Be more sellable

Sellability is the state of a product or service that allows you to sell it very quickly. If your business is sellable, it possesses several factors. They generally centre around your business being of high, marketable quality and having a strong, commercially viable structure.

Every business can be sold (saleability), but not all businesses are sellable. The level of salability of a company determines how easily you find buyers for it. Sellability increases competition among buyers for your business. 

With such increased demand for your business, the higher buyers are willing to pay for it, hence its higher valuation. Sellability is a crucial topic in business sales, and you can learn more about it here.

Less obvious factors

Beyond what has been discussed so far, there are some less obvious methods of increasing business value. You might not consider things like supplier contracts, office fixtures or location a key factor but these and other less well-known factors can affect your valuation.

One example of this is to use uniforms in your company. 

Business suits, aprons or branded shirts all count as uniforms, depending on the nature of your business. Beyond the practical reasons such as protection, easy identification and free advertising, there are other benefits that appropriate uniforms have:

  • They boost creativity
  • They increase productivity
  • They promote team spirit
  • They engender good customer relations and professionalism

By doing all these, uniforms help increase staff and customer satisfaction, all of which feed into the eventual business valuation.

Can your business model increase the value of your business?

So far, we have examined a couple of strategies you could employ to increase the value of your business. But have you ever considered the business model you run and how it contributes to making your business more valuable or otherwise? Well, we have, and we have identified how particular business models affect your business value.

Subscription business model

Essentially, a subscription business model ensures recurring revenue, and as you can imagine, this is an excellent way to have a secure income. But what exactly is a subscription model?

In this model, customers are retained because it is much cheaper to do so than to attract new customers. After customer retention, the model encourages the customers to spend more by either increasing the value of each spend or increasing the frequency of lower value spending. Either way, your customer generally spends more on your business, and your revenue remains fairly constant.

If the business you intend to sell possesses such features, it will have a high valuation. For one, buyers see the growth potential. They can also accurately estimate the cash flow. All these result in a highly valued business.

If you are looking to implement a subscription model in your existing business, read this article for ways to include it.

Scalable business model

Everyone hopes for their business to grow and expends efforts to make the company more productive and profitable as time goes by. However, it is an entirely different thing for the business to be scalable.

Scalability is the ability of a company to grow without any hindrance brought about by its structure or the resources available to it when faced with increased production. Growth is desirable, and scalability allows the company to grow very fast. 

Several aspects affect the scalability of a business. You can read more about it here: 6 Tips for Building A Scalable Business Model.

What you need to know is that buyers always look out for business with an ability to grow. If the company has all that is necessary to allow for accelerated growth, the buyers are much more willing to pay top dollar for it, resulting in a highly valued venture.

Self-running business model

You are getting ready to exit the business with the upcoming sale. However, on close look, the potential buyers realise that the business revolves around you. In your absence, the company cannot run as you make all the crucial decisions. They also find that customers are mostly used to relating to you and have no exposure to interacting with other staff members. 

Business model

Such a state reduces the price the buyer will be willing to pay for the business.

This is because, upon your exit, they will have to invest in training staff to be more competent in taking decisions on the day-to-day operations of the business. They will also have to involve in extensive customer reorientation, which could lead to a loss of a significant part of the customer base.

With all these, your business valuation ends up being much lower than the actual worth. On the other hand, a model wherein the business can operate without you gives buyers more confidence that the operations will not come grinding to a halt when you leave. Our ultimate guide to making your business self-running will provide more insight on this topic.

How to update my business model to increase my valuation

So far, you may have been operating your business on a model that is not optimised to give you the best value. Not a problem. There is always room to make gradual changes to your processes to result in a better business model.

Before we go on, we should note that eight factors can increase the value of a business. We have discussed some of these factors earlier in this article. You can leverage each of these drivers to alter your business model for a better business value.

How do you do this? For one, look out for legitimate opportunities in your market to have a continuous revenue stream. Buyers are kept interested in your business if you can demonstrate that customers are constantly returning, and more importantly, have a standing order or direct debit payment system for specific products. 

Another way to do this is to expand your growth potential by actively making your business more scalable. Find new markets to conquer and ensure a consistently high standard of delivery. When buyers see that you are flexible enough to fit into new locations or offer new products successfully, they will be willing to pay a premium price for the business.

For a light-hearted example of how we analysed Santa’s business model in terms of valuation, check out this post. The assessment touches on our eight business drivers and employs them to this very unique business model.

How to find out how much a business is worth

By now, you probably want to find out how much your business is worth and what actions you can take to increase your valuation. Doing this will involve a combination of the appropriate methods while considering the business status and models. All this taken together helps you to find out what your business is worth.

While you can undertake this by yourself, your best bet is to engage the services of a business valuation professional. 

At Uscita, we provide top-of-the-line business brokerage services for the manufacturing, engineering and professional services sector. We also deliver excellent business valuation services. Contact us today – and find out if you qualify for a free business valuation.

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