4 key methods to value a business

When analysing your business, in order to determine its fair market value, the approach taken by you or your business valuation expert will depend upon the type of business and your long-range strategic goals.

The business valuation method used for a simple manufacturing company will be different from that used for a complex service enterprise, such as a financial services company or an advertising agency. In addition, the business valuation model that you choose will depend upon your exit strategy such as selling the business as an ongoing concern, liquidation, or for estate purposes.

1. Asset-based method

If you are planning on a liquidation sale, for example, the business will be broken up into its component parts and sold off. In this case, the business valuation technique will probably be a straightforward calculation of the net book value. This asset-based valuation is based on the value of the buildings, vehicles, receivables, inventories, and other physical assets, less depreciation and debt. Because the activities of the business will cease, factors such as historical and projected revenues and goodwill are unimportant. One intangible asset that may have considerable value, however, is the brand name, which may be sold off separately. For example, in 1998 Rolls-Royce Plc sold the Rolls-Royce brand name to BMW for £40 million; the Rolls-Royce factories had been purchased earlier in the year by Volkswagen.

2. Historical earnings

If you intend to sell your business as a going concern, the business valuation model that you use must take into account the ability of the business to generate enough profits to pay off debt. Why? Because most buyers take out a loan in order to purchase a business. The buyer needs to ensure that the business will generate enough cash to pay off the loan within a defined time, usually four to five years. To determine the company´s ability to pay down debt, an appraiser will start with the historical free cash flow, which is defined as the company´s net after-tax earnings minus capital improvements and working capital increases, but with depreciation included.

3. Market method

In the real estate business, property is valued according to comparable properties that have recently sold. A similar valuation method exists in business, whereby, when valuing an ongoing concern the business appraiser identifies similar enterprises and creates a set of comparables. For example, if you wish to determine a valuation for your family-style restaurant, an appraiser will research similar restaurants and use their valuation when calculating yours.

4. Future earnings

For many prospective buyers, the most important factor is the projected future earnings. A business valuation based on the company´s expected earnings must use the discounted cash flow method to determine the net present value (NPV) of the business. While this business valuation method may come the closest to determining how much the business is really worth today, in practice, valuations based on future performance of a company are challenging because they require the appraiser to make projections and estimates about the company´s long-term performance. If you are valuing your business as a going concern, the business valuation method chosen by you or your appraiser will most likely be a combination of all four of these approaches.

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