Tax season is winding down, but hold onto those financial and tax documents. Today, we’re going to talk about how to calculate business valuation—the factors, metrics, and methods that tell us how much a business is worth and why.
What do I need to calculate the value of my business?
You need to start with a thorough analysis of your financials, including the following:
- Cash flow.
- Business expenses.
- Tangible assets.
- Intangible assets.
- Industry outlook.
Let's take a took at some simple valuation methods that you can take action on now.
Let’s take a look at the big two valuation methods.
What is the discounted cash flow method (DCF)?
The DCF method produces risk against future returns, with cash flow as the primary metric for assessing returns.
First, we’re looking at historical financial data to estimate future cash flow. Second, we take that estimate of future cash flow and put it in the context of future risk. Then, we can assess the business's present value. Is it complex? Yes, but not prohibitively so.
What is the times-revenue method?
It’s one of the simplest valuation methods: We define a business’s maximum value as a multiple of its revenue over a period of time. For example, we could take twelve months of revenue and multiply it by a factor of two. If a business is in a growth industry, increasing the factor from two to three would be reasonable.
We have 2x and 3x revenue, so why not make it an even 4x? Is there a limit? It sounds crazy, but in principle, there is no limit.
If you want to calculate a business's value, you must understand that valuation is a subjective exercise. Yes, we have numbers and formulas, but we decide when and how to use them based on the objective. Are you looking to arrive at a valuation that guides decision-making, or are you looking to sell your business?
Which valuation method should I use?
In general, I’d recommend the times-revenue method for new, small, or budding businesses. Established companies would be better served using DCF or exploring additional options.
Is there a specific process I need to follow to find out how much my business is worth?
Yes. To calculate business valuation, you need a process for regular and thorough maintenance of your accounting and financials. Take each of the steps below and turn into a process—a quarterly review, for example. It's predictable, easy, and gives you all the information you need to get to an estimated value faster and more accurately.
- Keep organized financial records.
- Track your business's revenue and cash flow.
- Assess your tangible and intangible assets.
This preparation is crucial to creating an accurate valuation, whether you do it yourself or work with a professional. The National Association of Certified Valuators and Analysts¹ provides professional support for entrepreneurs seeking business valuations.
Here are the benefits of business valuation.
You need to know what your business is worth, from the lowest low to the highest high. Because what really matters is what other people think your business is worth.
- Negotiate a favorable price if you’re selling your business.
- Appeal to investors and attract equity partners.
- Improve strategic decision-making and set benchmarks.
Annual or quarterly valuations are part of an overall assessment of your business’s financial health and growth prospects. You need to know what you’re worth, simple as that.
Let’s find out what your business is worth.
There’s a hard way and an easy way. The easy way is to schedule a consultation with someone who’s been doing this for fifteen years. I’d be happy to help.
Talk soon,
Jeremy A. Johnson, CPA
References
- NACVA | The Authority in Matters of Value | Business Valuation | Financial Litigation | Forensic Accounting | Financial Consulting [Internet]. www.nacva.com. Available from: https://www.nacva.com/
