How do you value a business?

Pick any company and ask five different experts to value it. You can guarantee they will give you five very different answers.

There is no “right” way to value a business and every valuation is subjective. Nonetheless, here are some basic concepts to get you started. The first thing when valuing a business is valuing its assets. This is fairly straightforward. Perhaps a business has assets of £1,000 and liabilities of £200, giving net assets of £800. Hence the business is worth £800, right? Not quite. A business is more than just its assets. It has loyal customers, a reputation, a brand, an annual profit (or loss), relationships with suppliers, procedures and processes, contracts with third parties, employees and other aspects that contribute to its value. How do we place a value on all of this? There are far too many valuation methods to list here, but let’s look at one relatively simple one: using a profit multiplier. Let’s say a business makes a profit of £100,000 per year. Using a profit multiplier of 5, we can calculate an indication of its value at £500,000. Another way to look at it is, if you invest £500,000 in purchasing the business, you will make a return of £100,000 a year, or 20%. The profit multiplier will be higher or lower depending on certain factors e.g. risk, industry, sustainability etc. Another more complex method is the Discounted Cash Flow (DCF) method. The first step is using the business’s current cash flow to estimate how much cash the business will generate in the foreseeable future. This is then adjusted using a long term interest rate to determine the “present value” of those cash flows. This method is popular as it’s based on cash flow, which is often thought to be a more important value indicator than revenue or profit. Yet common valuation methods can only take you so far. Valuation is subjective, largely based on forecasts, assumptions and estimates. In reality the most basic and perhaps the most accurate method of valuation is this: The exact amount that a business is worth is the price that someone else is willing to pay for it. Want to know more? Colour Accounting™ is our financial literacy course. Click here to secure your place. [traininglist slug=”colour-accounting-normal”]  ]]>