How Much Is Your Business Worth?

British enterprise is taking off as never before. Right now 30% of the working population in the UK is self employed. Hampshire has one of the highest numbers of entrepreneurs. As a result many businesses are being sold and bought. Here's our essential guide to the basics of valuing a business.

Crunching Numbers: Methods of Valuation
Quoted share prices indicate the value of companies listed on the stock exchange, but those not quoted need to figure out the value of their business in other ways.

Well, always remembering that the actual value of any business is basically whatever someone will pay for it, there are a variety of valuation methods that experts use. These are based on:

Price/earnings ratio
Entry cost
Discounted cash flow
Industry rules of thumb

To arrive at an asset valuation figure you total up the value of your assets and minus your liabilities. The assets that have been stated in the accounts form the net book value (NBV) of a business.

Next the NBV figures on the bigger assets need to be refined. fixed assets, such as property that has changed in value, or old stock which would need to be sold at a discounted price.

Price/earnings ratio
For businesses making good and sustainable profits that have a history of doing so, this is best. The value of the business divided by its net profits is called the price earnings ratio (or P/E ratio).

Look in newspapers financial pages, and online, to find out your own business P/E ratio by:

- Researching and comparing your business with others. What are your quoted competitors P/E ratios? How much have similar businesses been sold for?
- Looking into commercial conditions, as P/E ratios are weighted by market factors. If you are in a growth industry your P/E ratio is likely to be high.
- Considering forecast profit growth of the business. If you have repeat incomings to the business you will have a higher P/E ratio, as your business will be considered to be safer.

Next you multiply the businesss most recent profits after tax by the P/E ratio you have decided on. For example, if you used a P/E ratio of 6 for a business with post-tax profits of 150,000, the P/E valuation would be 900,000. Finally, calculate and adjust the post-tax profit figure to give a true sustainable portrayal of the business.

Entry cost
How much might it cost to start up a similar business from scratch? An entry cost valuation reflects what the process of setting up a similar business from scratch would cost, rather than buying an existing one.

First you need to work out the cost to the business over time of:

Buying its assets
Developing its products and services
Hiring and training staff
Building up a customer database
Setting up its website and promoting the business

Next compare by factoring any cost savings you could make if you used better technology or located to a less pricey area. Entry cost valuations should be based on the lower cost and more realistic alternative.

Discounted cash flow
For businesses that have heavily invested and are forecasting steady cash flow over many years, the value of the business may be calculated based on future cash flow forecasts, but they must be realistic.

This valuation focuses on the sum of the dividends that are forecast each year for the next 15 years, including a residual value at the end of this time period. Each future dividend value is calculated using a discount interest rate, bearing in mind the time value of money (that it is better to receive money today than tomorrow) and the risk involved.

Industry rules of thumb
This valuation technique uses an established formula for whichever sector the business belongs to. These are not set in stone, as a computer maintenance or web design firm might have no profits but 5000 contracts. A big competitor of such a business might be willing to pay 150 per contract to buy the business, as it could merge the two, widen its customer base and speed up growth.

A valuation can help raise equity capital to enable growth, decide on share price, or focus the management team on key issues. It will uncover any areas of weakness.

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