Business valuations are important for a number of reasons, not the least of which is selling the business so you can use the proceeds to finance your retirement or move on to another venture. But even if that's not your intent, a business valuation may be necessary for resolving certain legal issues and IRS or shareholder disputes. Business valuation is helpful for tax reporting, but it also comes in handy when raising capital or implementing an employee stock ownership plan.¹ As the owner, you may simply be curious to know how much your business might be worth.
A business valuation calculator is a helpful tool in this process, particularly when trying to determine if you can afford to buy a business or, on the other hand, if the business is worth its asking price.
How to calculate the value of a business
There are many ways to calculate a fair market value of your business. And while the methods differ in their approach, each one uses objective measures and attempts to evaluate various aspects of the business. The process could include everything from an examination of the company's management and capital structure to the market value of its assets. In the end, it all comes down to estimating how much the business is worth.
It helps to keep in mind that a wide range of internal and external factors play a role in determining business value. This could include financial strength, ownership/management strength, historical performance, forecast and future projections, industry trends, competition, market position and more.2
Business valuation methods
Let's take a look at four primary methods for determining the value of a business:
- Asset valuation: The asset-based approach focuses on the net asset value of the company, which can be obtained by subtracting total liabilities from total assets. This type of valuation can play an integral role in planning for a sale or liquidation, although it may need to be adjusted to reflect the market value of the assets and liabilities.3
- Discounted cash flow: This method, which is a bit complex, is based on future, or expected, cash flows. To determine the present value of those future cash flows, a discount rate is used to calculate the discounted cash flow. If the discounted cash flow is above the current cost of the investment, it may be the sign of an opportunity that could lead to positive returns. Keep in mind that because this method relies on an estimate of future cash flows, there are some limitations.4
- Earnings/revenue: The times revenue business valuation method looks at a stream of revenues over a period of time and then applies that to a multiplier. The multiplier will vary based on the industry or the economic environment. Similarly, the earnings multiplier approach is often used to more accurately predict future financial success. This method makes adjustments to the price-to-earnings (P/E) ratio to account for current interest rates.5
- Market comparison: Perhaps the simplest method, a market-based valuation multiplies the share price of the company by its total number of shares. However, this comes with some obvious challenges since sole proprietorships are owned by individuals and it's not easy to obtain public information on the sale of similar businesses.5
While business valuation formulas are helpful – and a necessary place to start – there's more to a company than the numbers. Consider additional factors, such as geographic location and the impact it might have on a potential buyer.
You may have a general idea how much your business is worth, but a formal business valuation will help you determine its true value. Regardless of your intentions, this is a process every business owner should engage in from time to time. In the meantime, these popular business insurance products from Nationwide can help build and protect what you've already accomplished.
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