How to value a company or business

If a business owner is planning to value his / her company it becomes imperative to correctly estimate the value of a business. Valuation is helpful for completing bank formalities and can also come handy if a business owner looks to expand his / her business or maybe looking for organic / inorganic growth. In case a business owner plans to sell his / her business, valuation of a business helps them to derive the expected value of acquisition

Company or business evaluation is a process and a set of procedures which is used to estimate its economic value in the market. So,

if you are looking for the valuation of your company, then either you are interested in selling it off or may be looking for investors who can invest in your business for its further growth.

Irrespective of your reason for valuing your business or company, it is important to use correct methods for the estimation to have an accurate estimation of its value. Because in case you are interested in selling your company or business, you should be clear about the price/value you can expect from a prospective buyer and in case you are out for exploring investment avenues, you need to know the correct value of your business for investors to show interest in it.

Valuation of a company or business is not a matter of somebody's opinion or conjecture because in reality, it is of any worth/value, only when either there is a genuine buyer for it or there is/are investor(s) who are ready to invest in it and the price paid by the buyer or the amount of money invested by the investor is the correct value of your company on that day.

What are the Factors Affecting the Valuation:

While evaluating your business or your company, you have to factor various points which can have an influence on its value, like:

1. Current state of the economy: If economy is in good state, chances are high that you get good value of your business.
2. Individual Circumstances/ Reasons for Selling: Value of your company is highly dependent on your reasons for selling it. For example, a forced sale may attract lesser value.
3. Competitors: Value or worth of your competitors plays a significant role in determining the value of your company.
4. Value of Assets: Real time value of assets and debts of your business/company is quite a critical factor in determining the worth of your company. These fall under tangible assets like property, machinery, inventory etc and are easier to value.
5. Reputation and Brand Name: If you have earned good reputation, then getting a good value for your company is not that difficult a task because if not for anything else, buyers and investors will be interested in getting associated with the brand name.
6. Intellectual Property Associated with it: Value of your company depends quite a lot on how many patents or other intellectual property you own. These fall under intangible assets and their estimation is quite complex as compared to their tangible counterparts.
7. Marketing Activity: If your company has managed to put up a good show in the market in terms of sales and marketing activity, then it might attract genuine buyers and investors.
8. Financial History: Value of your company depends very much on its financial history like cash flow, profits etc.
9. Regular Purchases/Orders
10. Strength of relationships with customers: If you have strong inter-personal skills with your customers, you can expect to get good value for your business because everybody wants to get associated with an appealing personality.
11. Loyalty of your Staff: In case you have loyal staff, word of mouth marketing about your company will be good and thus can help you in some way in getting a better deal.

Business or Company Value Assessment:

The business value is an 'expected price' at which the business will be acquired or sold. The following business valuation methods are used most commonly:

• Assessment based on 'book-value' or 'asset' – This method is based on facts and figures as it draws information from the balance sheet. For an ongoing business, assets in the balance sheet can likely generate profits in the future
• Stock market assessment – For a plc, listed in a competitive, openly-traded stock market, it reflects the demand and supply at any given moment. This can play an important role in the equity valuation
• Other methods – There are a numerous 'rules of thumb' based on Revenue or turnover; profit; Earnings Before interest, Tax, Depreciation and Amortisation (EBITDA); and Earnings before Interest and Tax (EBIT). However, these cannot individually help a buyer decide whether or not to acquire the company

How to Evaluate Your Company: Methods of Valuation

There are a number of methods through which you can evaluate your company’s net worth/ value; however there are three main approaches to valuing a business, which are:

1. Assets Valuation: This has to be the first step towards estimating the value of your company and you need to know how to evaluate the different assets and the liabilities, depending on their nature. Few assets are tangible in nature and you can estimate their net value for a quick evaluation however there are certain assets, which are intangible in nature. Tangible assets are those whom you can sell/dispose of faster as compared to intangible assets.

   Examples of tangible assets are: Equipments, Inventory, Cash, Investments, buildings, raw materials, spare parts etc.

   Examples of intangible assets are: Goodwill, trademark, patent, logos, company name etc.

   Liabilities include debts, outstanding taxes, mortgages, loans, leases, contracts etc.

   The starting point for an asset/liabilities based method is to have a look at the assets which are listed in the company’s account book, also known as Net Book Value (NBV) of your business. To have a better introduction with the economic reality, you have to refine the NBV figures by adding liabilities to it.

   In simpler words, add all the assets of your business and subtract the liabilities from it to have an asset valuation. So, in case your company has assets of £500,000 and liabilities of £150,000 then the asset valuation of your business is £350,000.

2. Cash Flow Analysis-Income Valuation:The Discounted cash flow (DCF) method uses estimation of future cash flow to value a company or business. While predicting the future cash flow, it is important to take into account the rates of inflation. Many a times it has that business buyers use a discount rate of 15-25% with regards to changes in inflation. The DCF-method is as precise as it gets, and looks at the business as an ongoing money-making machine. DCF analysis takes into account the future free cash flow projections and discounts them to reach at a present value estimate; this present value estimate is then used to assess the prospective investment. If the value, computed through DCF analysis, is higher than the current cost of the investment, it can be inferred that the prospect may be a good one. There are quite a few deviations when it comes to assigning values to cash flows and the rate of discount in a DCF analysis. Though the calculation might seem complex, the principle behind a DCF analysis is to estimate the wealth an investor will receive in the future from an investment, in tune with the time value of money.


3. EBITDA Method: This method is a variation of Income Evaluation Method and is known as Earnings Before Interest, Tax, Depreciation and Amortisation and is used to analyze a company's operating profitability before expenses like amortization, interests, depreciation are added.
4. Entry Cost Valuation: Entry cost valuation is a method used when you decide to start a similar venture from the beginning rather than buying it. In this case, you have to consider certain factors like how much cost it would take you to build up the required assets, building up customer base, training of workforce, developing products and services etc.

   For example, if you need £500,000 to buy the set-up equipment and £50,000 for overheads on monthly basis and require 12 months to set up your customer base. In this case, your company is already at a value of at least £1.1 million i.e. £500,000 + £50,000* 12.

5. Thumb Rule: Different industries have their own rules of thumb set for estimating their worth. In case of a retail company, its worth is dependent on annual turnover, number of outlets and number of customers.

   For example, if a hardware manufacturing business has 10,000 or more contracts but no profits. For one buyer, this could be of lesser interest as compared to another buyer who would like to purchase the business by paying £100 per share.

6. Price/Earnings Ratio: This method is used by the larger listed companies and it can be worked out either pre or post tax. A higher P/E ratio indicates higher earning and growth in future and thus can attract genuine investors as compared to companies with lower P/E ratio. However, while calculating P/E ratio, you must compare an apple to an apple rather than an apple to an orange, which means, you should compare P/E ratios of one company to the P/E ratio of other companies, either in the same industry or market.
   

   P/E ratio = Value of Business/Its profit after tax. So, you can use it to estimate value of your company i.e.

   Value of Business = P/E Ratio * Earnings after tax.

   For example, if a company has a share price of £50 per share and earnings per share after tax is £10. In this case, P/E ratio would be: £50/£10 = £5.

7. Multiple of Profits: This is a very subjective way of calculating a business value. In this method, you have to multiply the annual earnings, based on your prediction of how long your company will operate.

   Many a times, multiples of earnings is used as a business valuation method. This method is best suited for businesses or companies with a time-honoured financial history. Under this method, the Price/Earnings (P/E) Ratio corresponds to the value of the business divided by its net income after tax. For example, if a business had net income after tax of £100,000 and the business was offered £500,000 for it, then the P/E ratio will be equivalent to 5 (£500,000/£100,000). Businesses within certain industry sectors, such as technology and information technology (also referred to as TMT (Technology, Media, and Telecommunications) will naturally have a much higher P/E ratio than a real estate business such as an estate agency. It must to noted that this method is usually used by businesses with a track record of profitability