Business owners who are ready to sell their business will often wonder, what is my business worth? This is likely the first question they’ll ask themselves since it is the most important; the value of the business determines how much they can obtain if they sell the business. There are a number of different business valuation methods that are in use today, but three that any small business owner will want to know about are the asset approach, the discounted cash flow approach, and the comparable transactions approach.

Asset Approach to Valuation

This business valuation approach is done by determining the values of the assets and liabilities for the business. The liabilities are subtracted from the assets, and the difference is going to be the value of the business. This can be a great way to determine the value of the business if it’s simple to determine the value of all assets and liabilities. However, this doesn’t take into account things that are valuable to the business but that don’t have a price that is easily determined. Also, the owner of a small business keeps some of the assets, while paying off the liabilities. Call us today to find out what these are. For most small businesses, the asset method is only used in case of liquidation. In most cases, though the business is worth more than just the hard assets. The intangibles of the business most also be considered. This is where things get tricky. Read on to find out more.

Discounted Cash Flow Approach

This method takes into account what the business makes in the future. The future amount the business could earn is determined, then a discount rate is applied to determine the present value of those cash flows. This is the way Warren Buffet would value a business. This is the methodology he uses to find what the “intrinsic value” of a business is. This is also what the analysts and portfolio managers use on Wall St. You may find some of this discussed on financial television shows, such as those found on CNBC. Since underlying almost all stocks is a business, we can also apply this to small businesses. Since small businesses by nature are more risky than large businesses, the discount rate for small businesses are generally higher than for middle-market businesses or publicly-traded firms. With the new energy and marketing programs injected by the new owner, this can let potential buyers see how well the business could do in the future by comparing the current price of the business with the amount the business could earn in the next few years. If this value is larger than the current cost of the business, it can help attract more buyers when the business owner is ready to sell. This methodology is complex and fraught with endless possible input errors. This valuation method is best left to professionals who know those inputs, otherwise, a discounted cash flow could give nearly any value for a business. Luckily, I learned this methodology well in business school and as part of receiving my CFA and CAIA charters.

Comparable Transactions Approach

This is a common way to determine the value of a business. The business model is compared with similar ones that have been sold recently to determine the value of the business. This method takes into account the current market for buying and selling businesses. Many people would understand this as the “multiple” method. Meaning, many buyers will use last years’ earnings or an average of multiple years, if the business’s earnings are inconsistent, and use a multiple of those earnings. This multiple can change somewhat, depending on the stage of the business cycle. If the economy is at a low point, multiples tend to contract, while in bull markets they tend to expand. It can be an effective way to market a business and is one that has often been used in the past to determine the value of a business before it is sold. We would remiss if we did not mention that every business is different, so it is best to understand where your business stands, before going to the market. How much is your business worth? To a degree, that is in the eye of the beholder. We can let you know how buyers may view your business.

Choose the Right Valuation Approach

Business owners will want to make sure they take the time to learn more about the various approaches that can be used and work with a professional to ensure they find the right one to help them determine the valuation for their business to help them with a sale. A business broker or mergers and acquisitions advisor is going to be able to work with the business owner to determine which of these approaches is going to be the right one (or ones) to use for their business to prepare for a sale.

So which valuation method is the right one for your business and what are the differences between them for your business? Speak with a mergers and acquisitions advisor today to learn more about selling your business and about how to choose the right business valuation. How much is your business worth? This is an important step you’ll want to do carefully when you’re ready to sell your business. Call CGK Business Sales at 512-900-3770 to learn more.