BUSINESS

How To Calculate The Value Of A Business?

business-value

How much is my business worth? How to evaluate a company that you want to acquire? This is the crucial question in the sale, acquisition, or transfer of a company.

But estimating the value of a business is a complex operation, and there are many methods to do this.

Calculating the value of a business is not a simple exercise nor an exact science, and each method has its specificities and will give very different results. It may therefore be interesting to combine several methods to assess the company’s value as accurately as possible.

And rather than wait until the last minute to evaluate a business you want to sell or pass on, ask yourself what its real value is now. This will give you, if necessary, the time to put it in value to obtain the desired profit from it.

Do Not Confuse Value And Price

First of all, it should be noted that the value of a business does not necessarily correspond to its selling price. Indeed, the context in which the transaction takes place will impact the price.

Price follows the laws of supply and demand. It is, therefore, better to sell when the market is favorable and when the company shows promising results and is in a growth phase.

Whatever the circumstances, the price of a business depends on four elements:

  • The objective value of the company: based on annual accounts and other financial data
  • Intangible value: know-how, performance, customers, growth potential, etc. that influence the profitability of the company
  • Items related to the sale: forced sale, bankruptcy, or other
  • The quality of the negotiation: impact of the buyer’s strategy and his ability to develop his business.

Why Calculate The Value Of A Business

Knowing the value of a business is essential to determine a listing price and conduct negotiations. The sale, purchase, or transfer of a business is prepared upstream.

Evaluating a business well before its possible sale makes it more attractive when the time comes. But this assessment can also serve other purposes.

  • Sale or acquisition: beyond the book value, the company’s intangible assets, notoriety, and profitability will be the critical elements of the negotiation.
  • Transmission: Knowing your business’s value allows you to have all the cards in hand to argue with a future buyer.
  • Growth: growing your business can go through a call for financing. The value and potential of the company are solid arguments for investors. 

Three Evaluation Methods

There are several calculation methods for valuing a business. The main approaches used for unlisted companies combine a dynamic approach (calculation of profitability), an asset approach (balance sheet and company history), and a comparative approach (by analogy with other similar companies).

The Heritage Method  

The patrimonial method consists of determining the company’s value based on the past. That is to say, on the inheritance, it possesses fewer debts. It is the most used method because it is the easiest and quickest to implement. This method is based on the annual accounts for the last three years.

The value corresponds to the netbook assets (ANC) (balance sheet assets – actual debts). However, the ANC has its limits, and it should be corrected by considering the market value, deferred taxation, and the reclassification of unjustified provisions. We then obtain a corrected netbook asset (ANCC), which must be added to the goodwill (GW) of the company, that is to say, its capacity to create or destroy wealth.

The Cash Flow Method (DCF)       

This method is concerned with the future profitability of the company. Here we consider that the company’s value is equal to the present value of future cash flows. 

Concretely, this method starts from the business plan to determine the forecast cash flows (operating profit after tax + net depreciation expense + net investments + change in working capital). We then apply a discount rate (generally the average cost of capital) and determine the terminal value (estimated value at the end of the business plan’s horizon). The value of the business is determined by adding the cash flows and the terminal value.

This approach has the advantage of integrating future risks and uncertainties. But it is more complex to implement. And its quality depends on the soundness of the company’s forward-looking financial plan.

This model is often used to promote start-ups.  

The Comparative Method

This method, widely used by financial analysts and investors, consists of determining the company’s financial value by comparison with companies having similar characteristics. 

This method selects a sample of companies of comparable sizes operating in a similar industry and with similar growth prospects. The company to be valued is then compared to this sample using different valuation multiples (ratios based on net income, sales, EBIT, or EBITDA).

This method is very commonly used for SMEs and traditional operating companies.

Focus On Goodwill

Faced with the sometimes significant differences observed between the valuation based on profitability and asset values, analysts integrate the concept of goodwill to measure a possible outperformance or goodwill of the company, justifying a difference compared to other companies in the same sector of activity or of comparable size. However, the intangibility of measured intangible assets often gives rise to a great deal of discussion and negotiation between sellers and buyers.

The goodwill represents all intangibles (patents, trademarks, customer lists, exclusive contracts, niche in the market situation of the pension …). This value does not appear on the balance sheet but is an intrinsic part of the company’s valuation.

Also Read: Starting A Home Business – Advantages And Tips

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