Business Valuation Guide - How to value a business

When it comes to selling a business, the most important question you need to ask is - how much is it worth? Unsurprisingly, there are no precise ways to value a private business. The seller will want to drive the price up, and potential buyers will want the opposite. Although there are relatively easy ways to value certain parts of the business - such as stock, fixed assets (land, machinery, equipment, etc.), there may well be a sizeable intangible element to the value of a business.

Intangible elements would include "Goodwill" - this could include trademarks, and the reputation of the company. Such things are notoriously difficult to value, and in many cases will come down to how keen a potential buyer is to acquire the business in question. When looking at the overall value of a business, there are a number of different valuation methods which are commonly used - from using earnings multiples, to calculating how much it would cost to create a similar business.

In this article, we look at some of the most commonly used valuation techniques, and how other factors may influence the value of a business at any given time.

Common Business Valuation Methods

EARNINGS MULTIPLES

Quite often, multiple of earnings are used as a business valuation method. This method would be suitable for companies with an established financial history. The Price/Earnings (P/E) Ratio represents the value of the business divided by its post tax profits. It may not be easy deciding what P/E ratio to use, some industries, such as high tech / IT ones will have a much higher P/E ratio than, say, an estate agency. The P/E Ratios used in the financial press should be reduced significantly when valuing a small business. Large businesses are generally more established and broader-based therefore have higher barriers to entry. Small businesses have a narrower focus and are often more reliant on a single individual, so are inherently more risky. The higher risk involved in buying a small business, means the P/E ratio will be lower than that commanded by a large business.

Quite often, business advisers will suggest a valuation of around 3 or 4 times the annual post-tax profit, but higher valuations are possible.

ENTRY COST

Quite simply, this is the predicted cost to set up a similar business to that being sold. This would include the cost of developing a customer base and reputation, recruiting and training staff, purchasing assets and developing products and services.

ASSET VALUATION

This method is more appropriate for established companies with a large amount of tangible assets (such as property companies). The valuation is made by calculating the net realisable value of all assets.