Nov 11, 2023 MicroBilt News
Understanding the value of your business is vital for its overall health and well-being. And while many business owners believe they have a general understanding of their most valuable assets, a recent poll found that 98% of business owners aren't even in the ballpark. That's where business valuations come in.
In a nutshell, a business valuation, or company valuation, is the process of determining the economic worth of a business by appraising the value of various assets to arrive at a fair and objective estimate of its worth. While this can be challenging and often overwhelming, there are ways to simplify the process. Below is a quick guide to help anyone trying to understand the importance of business valuations and some practices to help them get started.
- Gain a better understanding of why businesses must evaluate their assets consistently.
- Find out what methods are the most commonly used to determine the company's total value.
- Learn how you can get a quick and accurate estimate of your business today.
What is the Purpose of a Business Valuation?
Most of the time, the purpose behind a company valuation is when a business is interested in selling a portion or all of its operation. However, the significance of the valuation also provides several other advantages. Below are the ten next most common reasons:
- Buying a Business: Prospective business buyers need a valuation to determine whether the purchase is financially viable and to negotiate a fair price.
- Mergers and Acquisitions (M&A): In M&A deals, the buyer and the seller must understand the target company's value to negotiate terms and make informed decisions.
- Estate Planning and Succession: Business valuations are crucial for estate planning to determine the value of the business for tax and inheritance purposes.
- Equity Financing: When a company seeks equity financing from investors or venture capitalists, a valuation helps to determine how much ownership equity should be exchanged for capital.
- Debt Financing: Lenders may require a business valuation as part of the loan application process to assess the company's ability to repay debt.
- Financial Reporting: Publicly traded companies must periodically evaluate the fair value of their assets, including the valuation of the business as a whole, for financial reporting purposes.
- Litigation and Disputes: In legal disputes, such as divorce settlements, shareholder disputes, or bankruptcy proceedings, business valuations help determine asset distribution and settlements.
- Insurance and Risk Management: Businesses may need to assess the value of their assets, including the business itself, for insurance coverage and risk management purposes to ensure adequate protection in case of unforeseen events.
- Strategic Planning: Businesses use valuations to assess their financial health and make informed decisions about expansion, diversification, or restructuring.
- Taxation: Business valuations are essential for various tax purposes, such as gift and estate tax, property tax, and determining the value of stock options for tax purposes.
How to Calculate a Business's Value
Multiple valuation techniques can accurately determine a business's value. Below are six of the most commonly used methods:
- Market Capitalization: The simplest business valuation method - with the big stipulation that your company must be publicly traded - is calculated by multiplying its share price by its total number of outstanding shares.
- Times Revenue Method: The times revenue approach involves applying a multiplier to a stream of revenues over a period of time, with the multiplier varying by industry and economic conditions.
- Earnings Multiplier: Similar to the previous method, the earnings multiplier can provide a more accurate assessment of a company's actual value as the company's profits are a more dependable indicator of financial success than sales revenue.
- Discounted Cash Flow (DCF): The DCF method involves projecting and adjusting future cash flows to current values. Unlike the profit multiplier method, the discounted cash flow method takes inflation into account when calculating the present value.
- Book Value: Put as simply as possible, the book value is calculated by subtracting the total liabilities from the total assets.
- Liquidation Value: The liquidation value of a business refers to the amount of cash it would receive if it sold all its assets and paid off all its liabilities immediately.
Who Can Help with the Company Valuation?
Although the above strategies should give you a glimpse into business valuations, knowing the methods does not mean knowing how to apply them. Organizations will hire accredited CPAs, or sometimes entire organizations with experience working with companies, to help them carefully analyze your business. When selecting that organization, be sure to look for Accredited Business Valuation (ABV) professionals who make it their living to provide fair and, most importantly, accurate estimates of your company.
We at MicroBilt understand how this can be a big step, which is why we have developed a suite of user-friendly tools to help business owners manage financial risks and accurately determine the value of their companies with a click of a button. Our product and service offerings, like Integra Comparative Profiler and Integra Industry Reports, provide crucial insights through accurate benchmarking data to keep you focused on a successful future. Learn more about how our products can help secure your business's value today!