Intuitively the value of a business should reflect its attractiveness and the generation of profits or dividends for its owners.
The fundamental basis of valuation is that:
• The value of an asset today is the present value of the future cash flows that the asset is expected to provide its owners.
So the value of a business (the asset) is the present value of future cash flows (or "adjusted" net profits).
The typical methods used to assess the value of a business include:
• Earnings Multiple.
• Discounted Cash Flow Analysis.
• Asset or Book Value.
• Return on Invested Capital.
Ideally the valuation range should be arrived at using a number of these valuation methods, and the range should be as narrow as the assessment process allows.
The valuation should be performed with a typical buyer or range of buyers in mind. After all, it is the buyer that ultimately decides the value of your business. The value is never known until the buyer gives you a cheque and the funds have cleared in your account. Until this point the value can only ever be estimated within a certain range.
There are three major assessment criteria for assessing the business value. These are:
1. Is the business transferable?
2. What is the relevant cash flow that the buyer will get a benefit from?
3. How attractive is the business to other buyers?
Is the Business Transferable?
No one wants to buy a business that they can't operate. If it relies on the owner to bring in the customers, service them and manage the business, there is a big question as to whether it can be transferred to someone else.
Many professional services businesses exist because of the relationship with the owners. If these relationships cannot be transferred, there is little or no value in the business.
What is the Cash Flow?
Cash flow refers to the operating profit generated over and above any wages or salaries that should be paid to the owner. If the owner is working in the business, then they should receive a wage for their efforts. But the business should also generate a cash flow in addition to this wage.
The cash flow can be adjusted to remove the effects of one-off expenses or revenue or non-operating items.
The higher the cash flow, the higher the business valuation.
What influences the attractiveness of the business?
The attractiveness of a business is a combination of the profitability and the key factors that influence its financial performance. These key factors contribute towards the Earnings Multiple. If one business is more attractive than another similar business it will have a higher Earnings Multiple and hence a higher valuation.
Selection of the Earnings Multiple will depend on factors such as:
• Type of business, industry and location.
• Size and profitability.
• Attractiveness of business.
• Demand for this type of business.
• Perceived risk of the business.
• Efficiency of operations of the business.
Understanding the value of your business will allow you to develop plans to increase the value. An experienced professional can identify the key factors in your business that will increase its value and what actions you should take. Knowing the value of your business is the starting point to change it, and is not just for those buying or selling.
We have helped hundreds of business owners understand the value of their business and discover the actions that increase the value of the business.